1. Review Baby! 1) Tools of Monetary Policy 2) Reserve Requirement 3) Deposit Expansion Multiplier

2. Reserve Requirement (aka Reserve Requirement Ratio or Reserve Ratio)
What are the three tools of monetary policy?
Reserve Requirement (aka Reserve Requirement Ratio or Reserve Ratio)
Discount Rate
Open Market Operations

3. What is the Reserve Requirement or Reserve Ratio?
The percentage of checkable deposits (demand deposits) banks may not lend out.

4. What is the Discount Rate?
The interest rate charged by the Fed when banks borrow money from the Fed.

5. What are Open Market Operations?
The buying and selling of government securities in order to expand or reduce the money supply.

6. What is the difference between the Discount Rate and the Federal Funds Rate?
The Discount Rate is the interest rate charged by the Fed when banks borrow from the Fed. The Federal Funds Rate is the interest rate charged by banks when they borrow from each other. The Federal Funds Rate is not set by the Fed, but by commercial banks. The Fed influences the Federal FundsRate by buying or selling government securities.

7. How can “new” money be created?
When banks make loans.
When the Federal Reserve (Fed) buys government securities (aka Treasury Securities or bonds) from the public or banks.

8. What are excess reserves, required reserves, and actual (total) reserves?
Excess Reserves = Demand Deposits banks may lend out
Required Reserves: = Demand Deposits banks may not lend out.
Actual Reserves = Required Reserves + Excess Reserves

9. Only its amount of excess reserves.
How much can any one bank lend out.
Only its amount of excess reserves.

10. The amount of excess reserves x the Deposit Expansion Multiplier
How much can the banking system lend out.
The amount of excess reserves x the Deposit Expansion Multiplier

11. If the Fed wants to fight recession what is its goal for AD? Why?
To increase AD in order to stimulate economic activity and provide more jobs.

12. If the Fed wants to fight recession what do they want to do with the money supply? Why?
Increase the money supply in order to stimulate economic activity. With a larger supply of money in banks, interest rates will decline and there will be increased excess reserves for lending. As such, C & IG borrowing and spending should increase.

13. If the Fed wants to fight recession it will __________ the Discount Rate. Why?
Decrease
This will allow commercial banks to borrow money from the Fed at lower interest rates. This would create more excess loans for banks to lend out, thus increasing the money supply and lowering interest rates.

14. If the Fed wants to fight recession it will ______________on the Open Market. Why?
Buy Government Securities (mainly bonds):
This will send more money into the economy and expand the money supply as those funds are deposited in the banking system. More excess reserves would be available for banks to lend out (at lower interest rates), thus increasing economic activity.

15. What is the Deposit Expansion Multiplier (aka the Money Multiplier) formula?
1/reserve requirement

16. How is the Deposit Expansion Multiplier used?
It is multiplied by the amount of excess reserves there are to determine the maximum amount of money creation by the banking system via loans and redeposits of loans.

17. If the Fed wants to fight inflation what do they want to do with the money supply? Why?
Decrease the money supply in order to reduce the price level. With a lower supply of money in banks, there will be decreased excess reserves for lending and interest rates will rise. As such, C & IG borrowing and spending should decrease causing the PL to decline.

18. If the Fed wants to fight inflation it will __________ the Discount Rate. Why?
Increase
This will make it more expensive for commercial banks to borrow money from the Fed. This would create fewer excess loans for banks to lend out, thus decreasing the money supply, and raising interest rates. Therefore consumers and businesses would borrow less for C & IG spending, and the PL would decline.

19. If the Fed wants to fight inflation it will ____________________ on the Open Market. Why?
Sell Government Securities (mainly bonds):
This will send less money into the economy and reduce the money supply. Fewer excess reserves would be available for banks to lend out, thus there would be fewer loans made and the PL would decline.