1. How does a change in money supply affect the economy? Relevant reading: Ch 13 Monetary policy

2. The central bank of the United States The Federal Reserve System

3. Clearing checks between private banks Holding bank reserves Providing currency Providing loans Functions of the Fed

4. Reserve requirement Discount rates Open market operations Monetary tools

5. The legal minimum amount of reserves a bank is required to hold; equal to required reserve ratio times deposits Required reserves

6. rd increases  excess reserves decreases and money multiplier decreases  money supply decreases rd decreases  excess reserves increases and money multiplier increases  money supply increases Required reserve ratio and money supply

7. The rate of interest the Fed charges for lending reserves to private banks Discount rate increases  excess reserves decreases  money supply increases Discount rate decreases  excess reserves increases  money supply decreases Discount rate

8. Open market purchase- the operation in which the Fed purchases government securities from the public to increase bank reserves Open market sale- the operation in which the Fed sells government securities to the public to decrease bank reserves Open market operations

9. The Fed buys $1000 worth of government securities from the public. The Fed writes a check to pay for the purchase. The seller deposits the check into the banking system Example: Open market purchase

10. Assuming rd= 0.1 Change in money supply = $1,000 x 1/0.1 = $1,000 x 10 = $10,000 Example: Open market purchase

11. The Fed sells $1000 worth of government securities from the public. The buyer withdraws money from the banking system to pay for the securities Example: Open market sale

12. Assuming rd= 0.1 Change in money supply = -$1,000 x 1/0.1 = -$1,000 x 10 = -$10,000 Example: Open market sale

13. Open market purchase- excess reserves increases, money supply increases Open market sale- excess reserves decreases, money supply decreases Open market operation and money supply

14. Money market Money demand – The quantity of money people are willing to hold at alternative interest rates, holding other things constant. Money supply- money stock available in an economy.

15. Money demand Interest rates as the price of money

16. Other determinants of money demand 1 Wealth Income Liquidity of alternative assets Risk of other assets Payment technology

17. Other determinants of money demand 2 As wealth decreases, money demand decreases As income decreases, money demand decreases As liquidity of alternative assets increases, money demand decreases As risk of other assets decreases, money demand decreases As payment technology allows transaction to be carried out without money, money demand decreases. Example: credit cards

18. Change in Money Demand 1 Households’ wealth increases

19. Change in Money Demand People become less risk averse to alternative assets such as stocks

20. Money Supply Assumed as exogenous

21. E.g. an open market purchase (to increase the money supply)

22. Money market equilibrium

23. Example: An increase in wealth i1

24. Example: The Fed raises the discount rate

25. Example: The Fed lowers required reserve ratio

26. Example: The Fed carries out open market purchase

27. Interest rates and the economy Interest rates decreases  investment increases  AD increases Interest rates increases  investment decreases  AD decreases

28. The effect of an expansionary policy- increasing money supply

29. The effect of a contractionary policy- decreasing money supply