Chapter 12 Monetary Policy Introduction Monetary Policy Federal

Chapter 12 Monetary Policy

Introduction Monetary Policy – Federal Reserve using the money supply and interest rates to stabilize the economy Introduction n n Board of Governors formulate policy 12 Districts implement the policy

Types of Monetary Policy n Easy (loose) Policy n n n n Increase the money supply Decrease interest rates Increase borrowing Increase spending (C+I) Increase aggregate demand Increase GDP Tight Policy n n n Decrease the money supply Increase interest rates Decrease borrowing Decrease spending (C+I) Decrease aggregate demand Decrease GDP

Tools n n Open market operations - buying and selling govt. bonds (most important) Reserve Ratio (requirement) - % of reserves held in the FED (least used) n n n 1937 – 20% 1958 – 13% 1980 – 12% 1992 – 10% Discount Rate - rate at which banks borrow from the FED (Used in emergencies)

Policy in the Gaps n Contractionary Gap (recession): Easy Money Policy to Inc MS, dec ir, inc borrowing and spending (C & I), inc AE & AD and inc GDP n n Buy Bonds Lower RR Lower DR Expansionary Gap (potential inflation): Tight Money Policy to dec MS, inc ir, dec borrowing and spending (C & I), dec AE & AD and dec GDP n n n Sell Bonds Raise RR Raise DR

Effectiveness n Faster and more flexible than Fiscal Policy n n n Can be reversed Less political FED targets the Federal Funds Rate through Open Market Operations

Disadvantages n Can’t force banks to borrow or not borrow