1. Copyright © 2002 Pearson Education, Inc. Slide 20-1

2. Copyright © 2002 Pearson Education, Inc. Slide 20-2 Chapter 20 Monetary Policy Tools

3. Copyright © 2002 Pearson Education, Inc. Open Market Operations Open market operations are Fed purchases and sales of securities in financial markets. The Federal Open Market Committee (FOMC) guides open market operations. Open market purchases are expansionary and open market sales are contractionary. The FOMC issues a general directive stating its overall policy objectives.

4. Copyright © 2002 Pearson Education, Inc. Types of Open Market Operations Dynamic transactions are intended to change monetary policy. Outright purchases and sales are types of dynamic transactions. Defensive transactions are aimed at offsetting fluctuations in the base. Repurchase and matched sale-purchase agreements are defensive transactions.

5. Copyright © 2002 Pearson Education, Inc. Advantages of Open Market Operations Control Flexibility Ease of implementation

6. Copyright © 2002 Pearson Education, Inc. Discount Policy Discount policy includes setting the discount rate and terms of discount lending. The Fed influences the volume of discount loans by setting their price and terms. The Fed discourages banks from heavy use of discount loans.

7. Copyright © 2002 Pearson Education, Inc. Types of Discount Loans Adjustment credit Seasonal credit Extended credit

8. Copyright © 2002 Pearson Education, Inc. Advantages of Discount Policy It is the most direct way for the Fed to act as a lender of last resort to the banking system. Changes in the discount rate have an announcement effect.

9. Copyright © 2002 Pearson Education, Inc. Slide 20-9 Figure 20.1 Discount Rate and Federal Funds Rate, 1970-2000

10. Copyright © 2002 Pearson Education, Inc. Reserve Requirements Reserve requirements mandate that banks hold part of their deposits in cash or Fed deposits. The Fed rarely changes reserve requirements. Every two weeks, the Fed monitors compliance with its reserve requirements. Debate continues on what the Fed’s role should be in setting reserve requirements.

11. Copyright © 2002 Pearson Education, Inc. Fed Watching: Analyzing the Policy Tools The market for reserves is also known as the federal funds market. Banks’ demand for federal funds increases as the federal funds rate declines. The supply of reserves is the supply by the Fed of borrowed and nonborrowed reserves.

12. Copyright © 2002 Pearson Education, Inc. Slide 20-12 Figure 20.2 Equilibrium in the Federal Funds Market

13. Copyright © 2002 Pearson Education, Inc. Effects of Changes in Policy An open market purchase decreases the equilibrium federal funds rate. An increase in the discount rate increases the equilibrium federal funds rate. An increase in reserve requirements increases the equilibrium federal funds rate.

14. Copyright © 2002 Pearson Education, Inc. Slide 20-14 Figure 20.3 Effects of Open Market Operations

15. Copyright © 2002 Pearson Education, Inc. Slide 20-15 Figure 20.4 Effects of Changes in the Discount Rate

16. Copyright © 2002 Pearson Education, Inc. Slide 20-16 Figure 20.5 Effects of Changes in Required Reserves