Monetary Policy Regulating Money Supply Review Quiz Trade

Monetary Policy: Regulating Money Supply

Review Quiz Trade Quiz #1: What are the two conflicting responsibilities of the Federal Reserve? Maximizing GDP & Employment while at the same time keeping inflation low

Review Quiz #2: What are two ways the Fed has some political independence when it comes to making their decisions? 14 -year term of office Don’t rely on money from Congress to keep running

Review Quiz #e: How many members of the Fed Board of Governors are there? 7

Review Quiz #4: How many District Branches of the Federal Reserve system are there? 12

Review Quiz Trade Quiz #5: What is the “discount rate? ” The interest rate that the Federal Reserve charges on direct loans to the 12 District Banks

Review Quiz Trade Quiz #6: Who is on the Federal Open Market Committee (FOMC? The 7 members of the Board of Governors and 5 of the presidents of the District Banks

Review Quiz Trade Quiz #7: What important decisions does the FOMC make? What the FFR should be and how much money there should be in the economy?

Federal Reserve Structure Discount Rate=Interest rate that the Fed lends money directly to District Banks (rarely used) Meets. Federal 8 times. Reserve a year to vote on Monetary Federal Open Board of Policy Market Committee= Governors (7 members) Ben Bernanke Chairman 7 Governors + 5 District Bank Presidents—meets 8 times per year Federal Funds Rate = Interest rate that the 12 District banks charge Each other on overnight loans SF Fed Building—Market Street 12 District Federal Reserve Banks Boston San Francisco New York Atlanta Chicago Dallas, etc. Member Banks All national banks Some state banks

The Money Market Supply of Money is fixed by the Fed The Money Market Interest Rate (FFR) Fed “controls” money supply through monetary policy S-Money Demand for money is downward sloping D-Money as interest rates ↓ more $ is demanded Qty $ Modern-day economies are almost entirely run on CREDIT—it’s all about borrowing CONSTANTLY

2 Types of Monetary Policy • LOOSE Monetary Policy (increasing the money supply) • TIGHT Monetary policy (decreasing the money supply)

Two Tools of Monetary Policy 1. Discount Rate Changes • Changing the interest rate at which District Banks borrow directly from the Fed

Two Tools of Monetary Policy 2. Open Market Operations – Federal Reserve action to buy or sell Treasury bonds -- This changes the money supply, which shifts the Federal Funds Rate *Demonstration

Loose (aka Expansionary) Monetary Policy • First, the Fed lowers the discount rate (i. e. 3% to 2%) • Next, the Fed uses Open Market Operations to increase money supply --the Fed Buys government bonds from anyone selling them Interest Rate (FFR) Price Level MS 1 MS 2 FFR 1 ----2 FFR ---------- MD Affects ADpeople borrow & spend more Qty of $ AS 1 AD 2 AD 1 Real GDP

Important Fact: Time Lag FYI: Both Fiscal Policy (6 -12 months) and Monetary Policy (12 -24 months) have a time lag Translation: they do not have immediate effect

Tight (aka Contractionary)Monetary Policy • First, the Fed raises the discount rate (i. e. 4. 5% to 5. 0%) • Next, the Fed uses Open Market Operations to decrease money supply --the Fed Sells government bonds to willing investors Interest Rate (FFR) MS 2 Price Level MS 1 Affects ADpeople borrow & spend less 2 FFR------- FFR 1 -------- AS 1 MD Qty of $ AD 1 AD 2 Real GDP

Economic Issue 1. Inflation rises to 10% 2. GDP growth is at 0. 9%; the inflation rate is 1. 8% 3. GDP growth rate is 2. 1% and the inflation rate is 3. 5% 4. Consumer confidence is falling; retail sales very weak; unemployment at 8. 1% 5. GDP growth is at 4. 2%; inflation is at 3. 6% Policy Type (Moderately Loose, Aggressively Loose, Moderately Tight, Aggressively Tight, or Take No Action) What action What would What change would the Fed want in the Money Fed take to happed to Supply would be needed to regarding the Federal bring about Discount Funds Rate the desired Rate (increase or change in FFR (increase or decrease) Decrease Money Supply What action in Open Market Operations would be needed to bring about the desired change in Money Supply (Buy or Sell Treasury Bills) Aggressively Tight Increase Discount Rate Increase FFR Moderately Loose Decrease Discount Rate Decrease FFR Increase Money Supply None OR Increase Discount Rate None OR Increase FFR None OR Decrease Money Supply None OR Sell T-Bills Decrease Discount Rate Decrease FFR Increase Money Supply Buy T-Bills Increase FFR Decrease Money Supply None OR Moderately Tight Aggressively Loose Moderately Tight Increase Discount Rate Sell T-Bills Buy T-Bills Sell T-Bills

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News Clips http: //video. msn. com/video. aspx? mkt=en-us&vid=2 d 392 a 8 b-ac 77 -4 e 73 -8999 c 31 db 8966 b 68 ***(4: 29) good clip when Fed was considered cutting FFR from 1. 5% http: //video. msn. com/video. aspx? mkt=en-us&vid=5 dc 4 a 263 -0085 -4 db 0 -aecb-81 f 39870 a 9 (roundtable on FFR increase to 4. 75%) (7: 40) http: //video. google. com/videosearch? q=federal%20 funds%20 rate %20 suze%20 orman&rls=com. microsoft: *&oe=UTF-8&start. Index=&start Page=1&um=1&ie=UTF-8&sa=N&hl=en&tab=wv# (Suze Orman on FFR) (4: 32) http: //www. asterpix. com/v/8654211/fed-cuts-interest-rates/ ***(first 45 seconds of 2 minute clip)

Economic Issue 1. Inflation rises to 10% 2. GDP growth is at 4. 2%; inflation is at 3. 6% 3. GDP growth is 2. 1% and the inflation rate is 3. 5% 4. Consumer confidence is falling; retail sales very weak; unemployment at 8. 1% 5. GDP growth is at 0. 9%; inflation rate is 1. 8% Policy Type (Moderately Loose, Aggressively Loose, Moderately Tight, Aggressively Tight, or Take No Action) Aggressive Contractionary Moderate Contractionary Take no action OR Mod. Contractionary Aggressive Expansionary Moderate Expansionary Action on Open Market Operations (Buy or Sell Treasury Bills Effect on Federal Funds Rate (increase or decrease Effect on the Money Supply (increase or decrease) Sell T-Bills Decrease Money Supply Increases FFR None OR OR Sell T-bills Decrease MS Buy T-Bills Increase Money Supply None OR FFR Decreases FFR

Monetary POLICY Monetary Policy will shift AD curve Economy in recession Price Level AS 1 Loose monetary policy needed AD 1 Real GDP AD 2 Buys Securities & lowers discount rate Money becomes cheaper; Interest rates go down AD shifts right

Economic Situation: GDP growth at +5. 0%, Inflation rising, Unemployment 3% Loose or Tight Monetary policy needed? Solution: Interest Rate Tight Monetary Policy MS 2 MS 1 Price Level AS 1 Affects AD i 2 AD 1 ----- i 1 -------- MD Qty of $ AD 2 End Result: Lower GDP & less inflation! Real GDP

Situation: GDP growth at -2. 0%, Unemployment 9% Loose or Tight Monetary policy needed? Loose Monetary Policy Interest Rate MS 1 MS 2 Price Level AS 1 Affects AD i 1 ----- i 2 -------- MD Qty of $ AD 1 Real GDP AD 2

Loose Monetary Policy LOWERS Discount Rate 1. Fed _____ 2. Open-Market Operations BUYS Securities Fed _____ Interest Rate Price Level MS 1 MS 2 Affects AD i 1 ----i 2 -------- AS 1 AD 2 MD Qty of $ AD 1 Real GDP

Tight Monetary Policy RAISES 1. Fed _____ Discount Rate 2. Open-Market Operations SELLS Securities Fed _____ Nominal Interest Rate MS 2 Price Level MS 1 Affects AD i 2 ----- i 1 -------- AD 1 MD Qty of $ AD 2 Real GDP