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Monetary Policy

Monetary Policy. Chapter 13 continued. In Plain English Video. Take notes Focus on the Board of Governors (BoG) Federal Reserve Banks (RB) Federal Open Market Committee (FOMC). Fed Funds Rate.

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Monetary Policy

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  1. Monetary Policy Chapter 13 continued

  2. In Plain English Video • Take notes • Focus on the • Board of Governors (BoG) • Federal Reserve Banks (RB) • Federal Open Market Committee (FOMC)

  3. Fed Funds Rate • FDIC member banks loan each other overnight funds in order to balance deposit accounts each day. • The ir they use to loan each other is the FFR. • The FOMC targets this rate by suggesting an increase or decrease in the ir • Currently at .25%

  4. Discount Rate • FDIC banks may borrow short term loans directly from the FED • This is the discount window and is set above the FFR (currently .5%) • Banks do not like to use the window—the FED is the “last resort” • FOMC sets the Discount Rate

  5. Prime Rate • ir that banks charge their most “credit worthy” borrowers • Historically, the Prime Rate has been 3% higher than the FFR • So it is 3.25% today

  6. Private Spending Multiplier (review) • 1/1-MPC or 1/MPS • Assume person A earns a new $1,000. Assume person A has a MPC of .9 and a MPS of .1 • Person B now has $900 to spend. Assume the same MPC and MPS. • MPC = $810 and MPS is $90 • Now person C has $810 to spend • MPC = $729 and MPS is $81

  7. Required Reserve • The amount of money the Fed requires each bank to hold (amount they are not allowed to loan) • Currently at 10%

  8. The Savings/Reserve Multiplier • 1/rr (required reserve)

  9. Reserve Multiplier example • Assume Bank A receives a deposit of $1,000. Bank A has a required reserve (rr) of 10%. • They must put $100 in the vault but can lend out $900. • Someone borrows the $900, uses it and it ends up in Bank B. • Bank B must now put $90 in the vault but can lend out $810 to a new person

  10. Easy Money Policy (expansionary) • The Fed wants the money supply to grow • Lower all interest rates = people will borrow more • Decrease the required reserve so banks can lend more • Buy back bonds (open market operation)

  11. Tight Money Policy (contractionary) • The Fed wants to get money out of the system • Increase all interest rates = people borrow less • Increase the required reserve so banks can lend less • Why take money out? • INFLATION • Sell bonds (open market operation)

  12. The Money Market: Interaction of Money Supply and Demand • Key Graph # 9 illustrates the money market. It combines demand with supply of money.

  13. If the quantity demanded exceeds the quantity supplied, people sell assets like bonds to get money. This causes bond supply to rise, bond prices to fall and a higher market rate of interest. • If the quantity of supplied exceeds the quantity demanded, people reduce money holdings by buying other assets like bonds. Bond prices rise and lower market rates of interest result.

  14. Monetary authorities can shift supply to affect interest rate, which in turn affect Ig and C and AD and ultimately output, employment and prices. • Key Graphs 9, 10, 11 and 12

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