Monetary Policy

March 31, 2017

                             3 tools of monetary policy
1. Reserve Requirement: If you have a bank account, where is your money?
The FED sets the amount that banks must hold
The reserve requirement (reserve ratio) is the percent of deposits that banks must hold in reserve (the percent they can not loan out)

• bank deposits- when someone (public or private) deposits money in the bank
• banks keep some of the money in reserve and loans out their excess reserves 
• The loan eventually becomes deposits for another bank that will loan out their excess reserves 

If there is a recession:

 Decrease the Reserve Ratio

• Banks hold less money and have more excess reserves 
• Banks create more money by loaning out excess 
• Money supply increases, interest rates fall AD goes up 

If there is an inflation: 

Increase the Reserve Ratio

• Banks hold more money and have less excess reserves 
• Banks create less money 
• Money supply decreases, interest rates up, AD down 

2. Open Market Operations (OMO): when the FED buys or sells government bonds/securities

• This is the most important and widely used monetary policy
• If the fed BUYS bonds- takes out bonds from economy and replace with money MS (up)
• IF the fed SELLS bonds - takes the money and gives the security to the investor. MS (down)

3.  Discount Rate: MANY different interest rates, but they tend to all rise and fall together

• It is the interest rate that the FED charges commercial banks for short-term loans.

Federal Funds Rate: the interest rate that bank charges another for overnight loans 

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