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Monetary Policy Tools. Chapter 16 Section 3 and 4. Money Creation. RRR – required reserve ration Cash deposit x (1/RRR) = the money multiplier Simplest way to change M2 Increase Reserves = Decrease in money supply Decrease Reserves = Increase in money supply
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Monetary Policy Tools Chapter 16 Section 3 and 4
Money Creation • RRR – required reserve ration • Cash deposit x (1/RRR) = the money multiplier • Simplest way to change M2 • Increase Reserves = Decrease in money supply • Decrease Reserves = Increase in money supply • Rarely used in today’s economy
The Discount Rate • This is the interest rate that the Fed charges on loans to financial institutions. • Usually will set a “target level” for loans to be set at. • Prime rate – rate of short-term loans to their best customers • Increase IR = less M2 • Decrease IR = more M2
Open Market Operations • Buying and selling bonds • the most important and most used monetary policy tool • Can be done smoothly and on an ongoing basis
How Monetary Policy Works • Money supply increase – interest rates decrease • Money supply decreases – interest rates increase
The Problem of Timing • When policy is made, it must be made at the correct time of the business cycle or adverse effects can take place. • Inside lag – the time it takes to implement monetary policy • Outside lag – the time it takes for monetary policy to have an effect • Is it better left alone?
