15 - 1 Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal

15 - 1Copyright McGraw-Hill/Irwin, 2002

Goals of Monetary Policy

Consolidated Balance Sheet of the Federal Reserve Banks

Tools of Monetary Policy

Federal Reserve Purchase of Bonds

Monetary Policy, Real GDP, and the Price Level

Monetary Policy and Equilibrium GDP

Effectiveness of Monetary Policy

Targeting the Federal Funds Rate

Monetary Policy and the International Economy

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THE FEDERAL RESERVE AND THE FEDERAL RESERVE AND THE BANKING SYSTEMTHE BANKING SYSTEM

Open MarketOpen MarketCommitteeCommittee

AdvisoryAdvisoryCouncilsCouncils

Board ofBoard ofGovernorsGovernors

12 Federal12 FederalReserve BanksReserve Banks

CommercialCommercialBanksBanks

Thrift InstitutionsThrift Institutions(Savings & loan associations,(Savings & loan associations,

mutual savings banks, credit unions)mutual savings banks, credit unions)

The PublicThe Public(Households and(Households and

businesses)businesses)











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MonetaryPolicy

FEDERAL RESERVE BANK OF THE U.S.

15C H A P T E R











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Fed Functions- Money Supply

• 1. Issuing Currency—Federal Reserve Notes—paper currency—issued by districtbanks. Money identifies what district it came from on upper left of front of bill.

• 2. Setting Reserve Requirements

• 3. Lending Money to banks/thrifts

• 4. Provides for check collection

• 5. Acts as fiscal agent—gov’ts bank!











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Fed Functions-Money Supply

• 6. Supervising banks

• 7. Controlling Money Supply– -To stabilize– -To influence expansion/contraction of

economy.











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GOALS OF MONETARY POLICY

…to assist the economy in achieving a full-employment, noninflationary level of total output











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CONSOLIDATED BALANCE SHEET OFTHE FEDERAL RESERVE BANKS

ASSETS• Securities• Loans to Commercial Banks

LIABILITIES• Reserves of Commercial

Banks• Treasury Deposits• Federal Reserve Notes











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TOOLS OF MONETARY POLICY

Open Market Operations

Buying Securities

From commercial banks...• Bank gives up securities• FED pays bank• Banks have increased reserves

From individuals...• Individual gives up securities• Individual deposits check in bank• Banks have increased reserves











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New reserves$800

ExcessReserves

$4000Bank System Lending

FEDERAL RESERVEPURCHASE OF BONDS

Purchase of a$1000 bondfrom a bank...

$200Requiredreserves

$1000Initial

Deposit

Total Increase in Money Supply ($5000)











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The Reserve RatioRaising the Reserve Ratio• Banks must hold more reserves• Banks decrease lending• Money supply decreases

Lowering the Reserve Ratio• Banks may hold less reserves• Banks increase lending• Money supply increases











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The Reserve Ratio

The Discount RateEasy Money Policy

• Buy Securities• Decrease Reserve Ratio• Lower Discount Rate











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The Reserve Ratio

The Discount RateEasy Money PolicyTight Money Policy

• Sell Securities• Increase Reserve Ratio• Raise Discount Rate











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The Reserve Ratio

The Discount RateEasy Money PolicyTight Money Policy

• Sell Securities• Increase Reserve Ratio• Raise Discount Rate

Discuss relativeimportance

of each control











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MONETARY POLICY, REAL GDPAND THE PRICE LEVEL

Cause-Effect Chain• Money supply impacts interest

rates• Interest rates affect investment• Investment is a component of

AD• Equilibrium GDP is changed











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Real domestic output, GDP

Dm

InvestmentDemand

Rea

l rat

e of

inte

rest

, i

10

8

6

0Quantity of money demanded and supplied Amount of investment, i

MONETARY POLICY AND EQUILIBRIUM GDPSm1

AS

AD1

P1

10

8

6

0

Sm2

AD2

P2

Money Supply Increases

Interest Rate Decreases

Investment Increases

AD & GDP Increaseswith slight inflation

If the moneysupply increasesto stimulate the

economy...

Pri

ce le

vel











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AD3

Pri

ce le

vel

Real domestic output, GDP

Dm

InvestmentDemand

Rea

l rat

e of

inte

rest

, i

10

8

6

0Quantity of money demanded and supplied Amount of investment, i

MONETARY POLICY AND EQUILIBRIUM GDPSm1

AS

AD1

P1

10

8

6

0

Sm2

AD2

P2

More Money Supply

Lower Interest Rates

More Investment

Still higher AD & GDPwith significant inflation

Sm3

P3If the money

supply increasesagain…











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MONETARY POLICY, REAL GDPAND THE PRICE LEVEL

Effects of an easy money policy

Effects of a tight money policy

Monetary policy & aggregate supply











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EFFECTIVENESS OF MONETARY POLICY

Strengths of monetary policy• Speed and flexibility• Isolation from political

pressure• Successes in the 1980s &

1990sShortcomings and problems• Less control?• Changes in velocity• Cyclical asymmetry











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TARGETING THE FEDERALFUNDS RATE

Generalized Interest Rate Changes

Money Supply Impact

The Federal Funds Rate

The Prime Interest Rate











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MONETARY POLICY AND THEINTERNATIONAL ECONOMY

• Net export effect• Macro stability and

the trade balance• The “Big Picture”

Chapter Conclusions











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Net Export Effect

• FED Contractionary: Raise interest rate:– Dollar goes up

– Exports fall

– Imports rise

– Therefore: Negative Net Export Effect

• FED Expansionary: Lower interest rate:– Dollar goes down

– Exports rise

– Imports fall

– GDP increases

– Positive net export effect

ENDBACK

monetary policy open-market committee reserve ratio discount rate easy money policy tight money policyvelocity of moneycyclical asymmetryFederal funds rateprime interest rate

Copyright McGraw-Hill/Irwin, 2002

http://www.mhhe.com/cgi-bin/mcbrue15.pl?url=origin15-1











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NextChapter 16

Extending the Analysisof Aggregate Supply

Documents

15 - 1 Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal