Monetary Policy in the United States

1. And the Federal Reserve 1 Monetary Policy By Tami Bertelsen

2. The Federal Reserve 2 Established in 1913 by Congress. Consists of 12 regional Federal Reserve Banks, 24 branch banks and hundreds of national and state banks. By Tami Bertelsen

3. Primary Functions 3 Supply the economy with fiduciary currency – supervises the printing of currency Provide a system for check collection and clearing Hold depository institutions reserve and sets the reserve requirement Act as the government’s fiscal agent – U.S. fiscal agent By Tami Bertelsen

4. Primary Functions 4 Supervise member banks Act as a lender of last resort Regulate the money supply Intervene in foreign currency markets to stabilize the value of the dollar By Tami Bertelsen

5. Federal Reserve deposits 5 Legal reserves – funds that depository institutions are allowed to claim as reserves Required Reserves – minimum amount of legal reserves. Excess Reserves = legal reserves minus required reserves By Tami Bertelsen

6. Required Reserve Ratio 6 The required reserve ratio is the percentage of total reserves that the Fed requires depository institutions to hold. By Tami Bertelsen

7. Balance sheet 7 The relationship between reserves and total deposits in depository institutions can be shown using a balance sheet. Assets – what is owned Liabilities – what is owed Net worth = assets – liabilities By Tami Bertelsen

8. 8 Example of a change in Balance Sheet - Starting Point By Tami Bertelsen

9. 9 Example of a change in Balance Sheet – Ending PointIf I write a check to you for $500,000, and you bank at Macrobank, a deposit of $500,000 comes into the bank. By Tami Bertelsen Note: This does not effect the overall money supply because they are just new reserves written from one bank to another. The Fed’s overall reserves remain the same

10. Open Market Operations The Fed can make a direct effect on the overall level of reserves. The Fed buys and sells U.S. Government securities in the open market. 10 By Tami Bertelsen

11. Open Market Operations example 11 By Tami Bertelsen

12. Money Multiplier 12 Actual change in money supply is equal to the actual money multiplier * change in excess reserves or 10*200,000=2,000,000 in our example. Gives the maximum change in the money supply due to a change in reserves. Mathematically it is equal to 1 / required reserve ratio. So, if the required reserve ratio is 10%, the multiplier would be 1 / 0.1 = 10. By Tami Bertelsen

13. Discount rateis the interest rate that the Fed changes its Members for certain short-term loans. Lowering the discount rate Counteracts a recessionary trend by making it easier for banks to increase their reserve funds. Raising the discount rate Tends to counteract inflation by making it more difficult for member banks to increase their reserves. 13 Discount Rate By Tami Bertelsen

14. The Fed can change the percentage of depositor’s money that commercial banks are required by the Fed to keep on deposit in cash. 14 Reserve Requirement Changes By Tami Bertelsen

15. To expand money supply (during deflationary periods) 15 1. Buy securities in the open market 2. Lower the discount rate 3. Lower reserve requirements By Tami Bertelsen

16. To tighten money supply (during inflationary periods) 16 1. Sell securities in the open market 2. Raise the discount rate 3. Raise reserve requirements By Tami Bertelsen

17. Demand for Money 17 By Tami Bertelsen

18. Demand for money curveInverse relationship between the Interest rate and the Quantity of Money 18 By Tami Bertelsen

19. Money Supply CurveThe quantity of money is fixed at a given time and is vertical. 19 By Tami Bertelsen

20. Direct Effect Indirect Effect An increase in money supply leads directly to an increase in aggregate demand. When there is excess money, some people deposit it in banks. These funds are then converted to loans at a lower interest rate. When interest rates fall, planned investment rises. When investment falls, real GDP falls and aggregate demand increases. 20 Money Supply increase effects on AD By Tami Bertelsen

21. Aggregate Demand 21 By Tami Bertelsen

22. Shift in Aggregate Demand 22 By Tami Bertelsen