Three tools of Monetary Policy 03/21/2016
The reserve requirement
- only a small percent of your bank deposit is in safe. The rest of your money has been loaned out. This is called "Fractional Reserve Banking"
The FED sets the amount that banks must hold.
The reserve requirement(reserve ratio) is the percentage of depend it's that banks must hold in reserve and NOT loan out...
- when the FED increases the money supply it increases the amount of money held in the bank deposits.
1. Recession: decrease the reserve ration banks that had less money and have more excess reserves.
2. Banks: create more money by loaning out success.
3. Money supply increases, interest rate falls, and AD goes up.
Inflation
1. Increase the reserve ratio; banks hold more money and less excess reserves.
2. Banks create les a money
3. Money supply decreases, interest rate goes up... AD goes down.
Discount Rate
The discount rate is the interest rate that the FED charges commercial banks.
Ex: If Banks of America needs $30 million, they borrow it from the U.S.
The FED controls but they mostly pay it back with interest.
Why?
- To increase the money supply, the FED should decrease the discount rate (EASY MONEY POlICY)
- To decrease the money supply the FED should increase the discount rate (TIGHT MONEY SUPPLY)
OMO also known as Open Market Operations
* the FED buys/sells government bonds (securities)
* This is the most important and widely used monetary policy.
1. To increase money supply, the FED should buy government securities.
2. To decrease the money supply, the FED should sell government securities.
Federal Fund Rate : FDIC Member banks loan each other over night loans...
Prime rate: Interest rate that banks give to their most credit worthy customer...
I really like your blog. The way that you set it up, with the different, and multiple pictures, helped me to understand the tools of monetary policy. I forgot that there was no single prime rate, and your pictures really helped to explain how all these tools can work and what type of policy it is under.
ReplyDeleteYour notes are good, and the pictures help a lot. Although the last picture for federal fund rate is a little confusing, a graph or some other type of illustration might have helped a little more.
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