1. The fed’s open market policy and Money supply
Activities
The fed’s open market policy
and
Money supply

2. 38.1
The FED wishes to decrease the money supply from $353 to $303 by open market operations
1. will the FED buy or sell existing Treasury securities?
2. what is the money multiplier?
3. what is the value of Treasury securities that need to be bought or sold?

3. 38.1
The FED wishes to decrease the money supply from $353 to $303 by open market operations
1. will the FED buy or sell existing Treasury securities? sell
2. what is the money multiplier? 10
3. what is the value of Treasury securities that need to be bought or sold? $5

4. 38.5 suppose banks keep zero excess reserves and the reserve requirement is 15%
5. what is the deposit expansion multiplier?
6. a customer deposits $100,000 in her checking account
How much of this can the bank lend to new customers?
How much must the bank add to its reserves?
In what two forms can a bank hold the new required reserves?
7. Suppose that the $100,000 had previously been held in Federal Reserve notes under the customer’s mattress and that banks continue to hold no excess reserves. By how much will the customer’s deposit cause the money supply to grow?

5. 38.5 suppose banks keep zero excess reserves and the reserve requirement is 15%
5. what is the deposit expansion multiplier? 6.67
6. a customer deposits $100,000 in her checking account
How much of this can the bank lend to new customers? $85,000
How much must the bank add to its reserves? $15,000
In what two forms can a bank hold the new required reserves? Vault cash or a Federal Reserve account
7. Suppose that the $100,000 had previously been held in Federal Reserve notes under the customer’s mattress and that banks continue to hold no excess reserves. By how much will the customer’s deposit cause the money supply to grow?
$566,110

6. 8. would a very low discount rate (encourage banks to borrow or discourage banks from borrowing) from the Federal Reserve? Why?

7. 8. would a very low discount rate (encourage banks to borrow or discourage banks from borrowing) from the Federal Reserve? Why?
A bank would be encouraged by a very low discount rate to borrow from the Fed, if it could make loans to new customers at a higher rate. It would have an incentive to make a profit.

8. 9. the federal funds rate is the interest rate at which financial institutions can borrow from other financial institutions. Suppose the federal funds rate is 5% and the discount rate is 4.5%. Why is it that a bank might choose to borrow in the federal funds market rather than getting the lower interest rate available through the discount window?

9. 9. the federal funds rate is the interest rate at which financial institutions can borrow from other financial institutions. Suppose the federal funds rate is 5% and the discount rate is 4.5%. Why is it that a bank might choose to borrow in the federal funds market, rather than getting the lower interest rate available through the discount window?
Banks can borrow from one another without oversight.
If a bank was to borrow from the FED, the lender of last resort, it might invite supervision or shake confidence of its investors

10. 10. in one country the reserve requirement is 100%
10. in one country the reserve requirement is 100%. What will be the deposit expansion multiplier?
11. If the Fed decided to implement a policy action designed to increase the money supply, in which direction would bank reserves and the federal funds rate change and why?

11. 10. in one country the reserve requirement is 100%
10. in one country the reserve requirement is 100%. What will be the deposit expansion multiplier?
One
11. If the Fed decided to implement a policy action designed to increase the money supply, in which direction would bank reserves and the federal funds rate change and why?
Bank reserves would increase
The federal funds rate would decrease

12. The loanable funds market
When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans
The money market
The loanable funds market MS s
MS1 s1
Nominal interest rate
Real interest rate d Dm Q Q1 Q Q1
Quantity of money
Quantity of loanable funds

13. When the Fed increases the money supply
39. When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans
The money market
When the Fed increases the money supply
What happens to the interest rate?
What happens to the quantity of money demanded?
What happens to loans and interest rates? MS
MS1
Nominal interest rate Dm Q Q1
Quantity of money

14. When the Fed increases the money supply
39. When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans
The money market
When the Fed increases the money supply
What happens to the interest rate? It declines
What happens to the quantity of money demanded? It remains the same
What happens to loans and interest rates? MS
MS1
Nominal interest rate Dm Q Q1
Quantity of money

15. The loanable funds market
When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, this initial increase in deposits, which increases bank reserves, allows banks to make more loans at a lower interest rate and the money supply is increased by the deposit multiplier
The money market
The loanable funds market MS s
MS1 s1
Nominal interest rate
Real interest rate d Dm Q Q1 Q Q1
Quantity of money
Quantity of loanable funds

16. Suppose the demand for money increases?
The money market
What happens to the interest rate?
What happens to the quantity of money supplied?
If the fed wants to maintain a constant interest rate, what policy must it take?
Why might the Fed want to maintain a constant interest rate? MS
Nominal interest rate
Dm1 Dm Q
Quantity of money

17. Suppose the demand for money increases?
The money market
What happens to the interest rate? It rises
What happens to the quantity of money supplied? It stays the same
If the fed wants to maintain a constant interest rate, what policy must it take? It must increase the money supply
Why might the Fed want to maintain a constant interest rate? To stabilize the amount of private investment, to prevent recession MS
MS1
Nominal interest rate
Dm1 Dm Q Q1
Quantity of money

18. Suppose there are two money demand curves – Dm and Dm1 – and the Fed increases the money supply
The money market
What happens to the interest rate with each money demand curve?
What effect would the increase on money supply have on
Consumption
Investment
Real output
Price level
How, in economic terms, would you describe the two money demand curves?
If the Fed is trying to keep the economy out of a recession, which curve would it prefer to represent the economy? MS
MS1
Nominal interest rate Dm
Dm1 Q Q1
Quantity of money

19. Suppose there are two money demand curves – Dm and Dm1 – and the Fed increases the money supply
The money market
What happens to the interest rate with each money demand curve? Interest rates decrease with either, more with MD1
What effect would the increase on money supply have on
Consumption rises
Investment rises
Real output rises
Price level rises
How, in economic terms, would you describe the two money demand curves? MD1 is more interest inelastic than MD
If the Fed is trying to keep the economy out of a recession, which curve would it prefer to represent the economy? It would prefer MD1, a small change in money supply produces a bigger response MS
MS1
Nominal interest rate Dm
Dm1 Q Q1
Quantity of money