1. Who Creates Monetary Policy? 2. What are the 3 tools of Monetary Policy? 3. What would the Fed want to do to the money supply if there was high unemployment? 4. How would the Fed increase the money supply using the 3 tools?

Money is anything that acts as a medium of exchange in an economy. M1 = Coins, Paper Money, and Checkable Deposits. M2 = M1 + Savings Deposits, including Money Market Deposit Accounts + Small Time Deposits + Money Market Mutual Funds

If you have a bank account, where is your money?  Only a small percent of your money is in the safe. The rest of your money has been loaned out.  This is called “Fractional Reserve Banking”  The FED sets the amount that banks must hold  The reserve requirement (reserve ratio) is the percent of deposits that banks must hold in reserve (the percent they can NOT loan out)

If the Fed wants to increase the money supply, it will…  Decrease the reserve ratio  And Vice Versa

 Example: Assume the reserve ratio in the US is 10%  You deposit $1000 in the bank  The bank must hold $100 (required reserves)  The bank lends $900 out to Bob (excess reserves)  Bob deposits the $900 in his bank  Bob’s bank must hold $90. It loans out $810 to Jill  Jill deposits $810 in her bank  SO FAR, the initial deposit of $1000 caused the CREATION of another $1710 (Bob’s $900 + Jill’s $810)

 The Money Multiplier - The amount of money that banks generate with each dollar of reserves.  Money Multiplier = 1/Reserve Ratio  So, what is the money multiplier if the RR =.2?  1/.2 = 5

1. What is the money multiplier if the reserve requirement is 10%? 5%? 20%? 2. If the Fed buys $5 billion in bonds and the reserve requirement is 5%, what is the increase in the money supply? 3. If Susie deposits $100 in the bank and the reserve requirement is 20%, what is the increase in the money supply?

1. If there is a recession, what should the FED do to the reserve requirement? (Explain the steps.)  Decrease the Reserve Ratio 1. Banks hold less money and have more excess reserves. 2. Banks create more money by loaning out excess reserves. 3. Money supply increases.