Presentation on theme: "Taxes, Fiscal, and Monetary Policies"— Presentation transcript:
1 Taxes, Fiscal, and Monetary Policies Unit 7 Macroeconomics:Taxes, Fiscal, and Monetary PoliciesChapters 16.3EconomicsMr. Biggs
2 Monetary Policy Tools Money Creation The Department of the Treasury is responsible for manufacturing money.The Federal Reserve is responsible for putting dollars into circulation.Money creation - The process by which money enters into circulation.
3 How Banks Create MoneyMoney creation does not mean the printing of money.Banks create money by simply going about their business.For example, if you take out a loan for $1,000 and then deposit the $1,000, you have increased the money supply by $1,000 because demand deposit account balances are included in M1.Using the fractional reserve banking system, banks make money by charging interest on loans.Required reserve ratio (RRR) - Ratio of reserves to deposits required by the Federal Reserve.
4 The Money MultiplierThe money creation process will continue until the loanamount becomes very small.Money multiplier formula - The amount of new money thatwill be created with each demand deposit.In the real world, people hold some cash outside thebanking system, meaning that some funds leak out of themoney multiplier process.Also, banks sometimes hold excess reserves which are also a leaks.Excess reserves - Reserves greater than the required amount.
5 Reducing Reserve Requirements The simplest way for the Fed to adjust the amount of reserves in the banking system is to change the required reserve ratio (RRR).Reducing Reserve RequirementsA decrease in the RRR would free upmoney for banks to make more loans and would also increase the money multiplier.This causes the money supply to increase.Increasing Reserve RequirementsA slight increase in RRR would forcebanks to hold more money in reserve.This causes the money supply to contract.This is an effective but disruptivestrategy and is not used very often.
6 Reducing the Discount Rate The discount rate is the interest rate that the FederalReserve charges on loans to financial institutions.Changes in the discount rate affects the cost of borrowingfrom the Fed and if it costs banks more to borrow fromthe Fed, they will raise their prime rate.Prime rate - Rate of interest banks charge onshort-term loans to their best customers.Reducing the Discount RateA decrease in the discount rate makesbanks more willing to borrow from the Fed.This causes banks to increase lending,causing the money supply to expand.Increasing the Discount RateAn increase in the discount rate makesbanks less willing to borrow from the Fed.This causes banks to reduce lending inorder to build reserves, causing the money supply to contract.
7 Open Market Operations Federal Open Market Operations areby far the most-used monetary policy tool.Open market operations - The buying andselling of government securities to alter the money supply.Bond PurchasesThe Fed’s (FOMC) purchase of treasury bonds increases reserves in the banking system.This causes banks to increase lending,causing the money supply to expand.Bond SalesThrough treasury bond sales, the Fedremoves reserves from the banking system.This causes banks to reduce lending,causing the money supply to contract.
8 Using Monetary Policy Tools Open market operations are the most used of the Federal Reserve’s monetary policy tools.The Fed changes the discount rate less frequently.Open market operations or changes in the discount rate do not disrupt financial institutions like changing the reserve requirement.Today, the Fed does not change reserve requirements to conduct monetary policy.