Monetary Policy Notes

Fiscal Vs. Monetary Policy

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The FED control money supply, issue paper currency, set reserve requirements and hold reserves of banks,lend money to banks & charge them interests,acts as personal bank for government, supervises member banks

The FED requires banks to always have some money readily available to meet consumers' demand for cash
- The amount set by the FED is required reserve ratio
- The RR is the % of demand deposits (checking account balances) that must not be loaned out
- typical RR = 10%

Reserve Requirement
- Required Reserve Ratio is % of demand deposits (must not be loaned out

FEDS Functions
1. Control money supply
2. Issue currency
3. Set reserve requirements and hold reserves of banks
4. Lend money to banks and charge them interest check clearing service for banks
5. Acts as personal bank for government
6. Supervises member banks

1. Reserve requirement
If there’s a recession we should decrease reserve ratio
- Banks hold less money and have more excess reserves
- Banks create more money by loaning excess
- Money supply increases, interest rates fall, AD goes up
If there’s inflation increase RR
- Banks hold more money and have less ER
- Banks create less money
- Money supply decreases, interest rates up, AD down


2. Discount Rate
a. The interest rate that the Fed charges commercial banks
To increase the MS, the Fed should decrease the Discount rate.
To decrease the MS, the Fed should increase the Discount rate.


3. Open Market Operations
a. The Fed buys/sells government bonds (securities)
b. This is the most important and widely used monetary policy
To increase the MS, the Fed should buy government securities
To decrease the MS, the Fed should sell government securities