1. Monetary Policy
Chapter 15

2. Review of CHP 13
The Fed’s Board of Governors formulates policy, and the 12 Reserve Banks implement the policy
Fundamental Goal – Aid the economy in achieving full employment output with stable prices (Done by manipulating the money supply and size of bank’s excess reserves)

3. Power of Monetary Policy
The ability to control or manipulate the money supply cannot be overstated in terms of power
Prior to the current financial collapse, Alan Greenspan was regarded as the 2nd most powerful man in the world

4. Federal Reserve Balance Sheets
The Asset side contains the securities (government bonds) held by the Fed as well the loans it has made to commercial banks
The liability side contains three major items. They include – commercial bank reserves (held as deposits), U.S. Treasury deposits (tax receipts & loan payments), cash in circulation

5. Tools of Monetary Policy
Open Market operations – Fed’s buying and selling of government bonds
Buying bonds from a commercial bank increases reserves of the bank
Buying from public on the open market will also increase bank reserves.

6. The Open Market Cont’d
The buying and selling of these bonds by the Fed will essentially control the money supply by either creating or diminishing bank reserves.
If the Fed buys, bank reserves increase and so does money supply
The inverse occurs when the Fed sells

7. Reserve Ratio Tool
Raise the reserve ratio will increase required reserves and shrink excess therefore decreasing money supply by a multiple amount of the change in excess reserves
The inverse is again true the reserve ratio is decreased
Reserve ratio average is 10%, rarely changes however due to concerns with instability

8. Interest Rate Change by the Fed
This represents the 3rd tool for controlling money supply (aka the discount rate)
Increase the rate signals to banks that borrowing will be more difficult and therefore decreases excess
Once again, the inverse is true

9. Easy Money vs Tight Money
Easy Money – Expansion by the Fed of the money supply
Tight Money – Contraction of the money supply

10. Aggregate Supply & Monetary Policy
Easy Money Policy may be inflationary if full employment – should not be used during economic boom
Tight Money Policy may decrease inflation. However, if enacted during a recession it may make worse unemployment & the recession

11. Strengths of Monetary Policy
Takes effect much quicker than fiscal policy
Much less political. Fed members serve 14 year terms to allow them to make good but sometimes unpopular decisions
Fed Policy credited with the prosperous 80’s & 90’s, blamed for the current crisis.