1. Monetary Policy
Econ 11/14

2. Warm Up
What is the difference between monetary and fiscal policy?

3. Fractional Bank Reserves
Remember we discussed that banks are required by law to keep a certain amount of cash/coins in their vaults (reserve requirement). Right now that is 10% which means if you deposit $100 the bank is only required to hold $10.
The rest of the money is called excess reserves and the bank is allowed to loan out to other customers and charge interest on that loan.
Banks can also use excess reserves to buy federal bonds or securities that earn interest from the federal government. When the demand for loans increases, they liquefy—convert these bonds into cash.

4. Monetary Policy The Fed’s most important job is monetary policy
Monetary policy: the expansion or contraction of the money supply in order to influence the cost and availability of credit
The Fed has 3 major and 2 minor tools to conduct monetary policy
Each tool affects the amt of excess reserves in the system

5. Monetary Policy
Easy money policy: the Fed allows the money supply to grow and interest rates to fall.
When interest rates are low, people buy on credit and take out loans—this stimulates the economy
Tight money policy: the Fed restricts the growth of the money supply which drives interest rates up.
When interest rates are high people borrow and spend less—this slows economic growth

6. Monetary Policy Tools
Reserve requirement—Fed can change the requirement of how much money a bank holds at a time which could increase or decrease how much money is loaned
Fed doesn’t choose to use this tool much because others are better
2. Open Market Operations—buying a selling of government securities/bonds.
This is the most popular tool
When Fed sells securities, it decreases the supply of money which increases interest rates
If it buys back securities, it increases the money supply which decreases interest rates
FOMC is the committee that conducts these transactions, it is located at NY’s district bank

7. Monetary Policy Tools
3. Discount rate—the interest the Fed charges on loans to financial institutions. Banks can borrow from the Fed, if they do money supply is less and interest rates go up.
4. Margin Requirements—minimum deposits left with a stockbroker to be used as down payments to buy securities. Fed sets this requirement and monitors the stock market
This tool is not used often

8. Monetary Policy Tools
5. Moral Suasion—the use of persuasion such as announcements, press releases, articles in newspapers and magazines, and testimony before Congress.
If the Fed gives their opinions on how thing are going economically or what might happen in the future, people and banks sometimes react
6. Selective Credit Controls—credit rules pertaining to loans for specific commodities or purposes.
Sometimes used during economic struggles or uncertainty like wartime. Ex. Minimum down payments on cars during WWII so that less people would buy goods and use up materials needed for the war