Textbook PowerPoints = TMI
Maurer’s PowerPoints = JEI
Chapter 15 – Monetary Policy
Essential Question #1
What is monetary policy?
When the Federal Reserve manipulates the money
supply (increases it or decreases it).
Chapter 15 – Monetary Policy
Essential Question #2
Why would the Fed want to manipulate the money supply?
To change the interest rate.
a. A lower interest rate will increase investment
spending, shift AD to the right, increase real GDP, and
decrease unemployment.
b. A higher interest rate will decrease investment
spending, shift AD to the left, and limit inflation.
The Money Market
Chapter 15 – Monetary Policy
Essential Question #3
What are the tools of monetary policy?
1. Open-Market Operations – Buy or sell
bonds on the open market.
2. The Reserve Ratio – They can raise it or lower it.
3. The Discount Rate – This is the interest rate at which
commercial banks can borrow from the Federal Reserve.
#1 - Open-Market Operations
• By far, the most used and most important monetary
policy tool the Federal Reserve has.
• When the federal reserve buys bonds, it increases
banks reserves, increasing the money supply,
lowering interest rates.
• When the Federal Reserve sells bonds, it decreases
bank reserves, decreasing the money supply,
increasing interest rates.
Open Market Operations
• Fed buys $1,000 bond from a
commercial bank
New Reserves
$1000
Excess
Reserves
$5000
Bank System Lending
Total Increase in the Money Supply, ($5,000)
LO2
33-7
Open Market Operations
• Fed buys $1,000 bond from the public
Check is Deposited
New Reserves
$1000
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
Reserves
$1000
Initial
Checkable
Deposit
Total Increase in the Money Supply, ($5000)
LO2
33-8
#2 - The Reserve Ratio
• It should be obvious how lowering the reserve
ratio would expand the money supply (banks
could lend more, creating more money).
• Raising the reserve ratio would obviously have
the reverse effect.
• Reserve ratio last changed in 1992
#3 – The Discount Rate
• This is the interest rate that the Federal Reserve
charges commercial banks to borrow money.
Commercial banks can borrow excess reserves
from the Fed.
• A lower discount rate means banks will borrow
more reserves from the Fed and be able to lend
more.
• Higher discount rate does the opposite.
• The discount rate is a passive tool – the Fed
mostly changes it to keep it in line with other
short-term interest rates.
Expansionary Monetary Policy (Easy Money)
Problem: Unemployment and Recession
Fed buys bonds (or lowers RR, or lowers discount rate)
Excess reserves increase
Money supply rises (remember the money multiplier!)
Interest rate falls
Investment spending increases
Aggregate demand increases
Real GDP rises, unemployment falls
LO4
33-11
Restrictive Monetary Policy (Tight Money)
Problem: Inflation
Fed sells bonds (or raises R.R., or raises Discount Rate)
Excess reserves decrease
Money supply decreases (remember the money multiplier!)
Interest rate increases
Investment spending decreases
Aggregate demand decreases
LO4
Inflation declines
33-12
LRAS
Price Level
SRAS
P
AD
YF
Real GDP
The Federal Funds Rate
• The Federal Reserve conducts monetary policy
to change the Federal Funds Rate.
• It cannot change the Federal Funds Rate
directly. It does it by increasing or decreasing
banks excess reserves.
Monetary Policy
10
8
Prime interest rate
Percent
6
4
Federal funds rate
2
0
1998
1999
2000
2001 2002
2003
2004
2005
2006
2007
2008
2009 2010
Year
33-15
Federal Reserve Balance Sheet
October, 2014 (in Billions)
Assets
Liabilities and Net Worth
Securities
Loans to Commercial
Banks
All Other Assets
Total
$4,219
0
268
$4,487
Reserves of Commercial
Banks
Treasury Deposits
Federal Reserve Notes
(Outstanding)
All Other Liabilities and
Net Worth
Total
$ 2,799
119
1,255
314
$4487
Source: Federal Reserve Statistical Release, H.4.1, Oct. 29, 2014, http://www.federalreserve.gov
LO2
33-16
• Advantages over fiscal policy
–Speed and flexibility
–Isolation from political pressure
LO5
33-17