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AP Macroeconomics

AP Macroeconomics. Monetary Policy. Being forced to work, and forced to do your best, will breed in you temperance and self-control, diligence and strength of will, cheerfulness and content, and a hundred virtues which the idle will never know.      Charles Kingsley.

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AP Macroeconomics

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  1. AP Macroeconomics Monetary Policy

  2. Being forced to work, and forced to do your best, will breed in you temperance and self-control, diligence and strength of will, cheerfulness and content, and a hundred virtues which the idle will never know.     Charles Kingsley

  3. Institutions that Carry out Monetary Policy • Central bank (The US Federal Reserve, Bank of Japan, European Central Bank, Bank of England…)

  4. Goals of Monetary Policy and the Institutions • efforts to promote: • Full employment • Price stability • Long-run economic growth

  5. How do central banks try to achieve their goals? • They control the money supply and interest rates.

  6. Expansionary (Easy Money) Monetary policy designed to counteract the effects of recession and return the economy to full employment. Contractionary (Tight Money) Monetary policy designed to counteract the effects of inflation and return the economy to full employment. Types of Monetary Policy

  7. Tools of Monetary Policy • Required Reserve Ratio • The Discount Rate • Open Market Operations (OMO)

  8. All that is necessary for the triumph of evil is that good men do nothing. --Edmund Burke

  9. The Required Reserve Ratio • The % of demand deposits that must be stored as vault cash or kept on reserve as Federal Funds in the bank’s account with the Federal Reserve. • There are two types of reserves: • Required—the money that the bank HAS to have on hand or on reserve in the bank’s account with the Fed. • Excess—all other demand deposits. • The bank can NOT loan out required reserves. • The bank IS ABLE to loan out excess reserves.

  10. Federal Funds Rate • The Fed Funds rate is the interest % banks pay each other for overnight loans of Federal Funds

  11. Why do banks need overnight loans? • Banks are like any other business in that they seek to maximize profits. How do banks make profit? • Banks make a profit by loaning out as much of their excess reserves as possible and charging interest to the borrower. • What if they’ve loaned out too much and they don’t have enough “in reserve”??? • Dun-Dun-Dun!!! • Then they’ll need to get some cash—fast!

  12. Why do banks need overnight loans? (cont) • If, in the course of business, banks have loaned out more than their excess reserves and do not have enough money to satisfy the required reserve ratio… • Then they must either borrow from the Fed’s discount window, or most likely borrow from each other in the Fed Funds market. • Federal Funds Rate is the interest rate banks charge each other for overnight loans

  13. The Discount Rate • The interest % banks pay theFedfor overnight loans in order to meet the required reserve • Decreasing the discount rate lowers the cost of borrowing for banks. • This creates an incentive for banks to loan more of their excess reserves. • If they loan out “too much” they can borrow cheap money from the Fed in order to meet their reserve requirement. • The effect of a decrease in the discount rate is to increase the money supply and is therefore expansionary.

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