Monetary Policy Section 5 Modules

In Plain English--The Federal Reserve Video  Take notes  Focus on the Board of Governors (BoG) Federal Reserve Banks (RB) Federal Open Market Committee (FOMC)

Federal 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 “suggests” this rate  Currently at.25%

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.75%)  Banks do not like to use the window—the FED is the “last resort”  FOMC sets the Discount Rate

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

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

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

The Savings or Money Multiplier  1/rr (required reserve)

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

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)

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)

Big Graphs 9 and 10  Money market  Loanable funds

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

 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.

 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