Monetary Policy
Temirbekova Aelina
1) Monetary policy refers to the action the FED takes to influence economic
performance
The FED can use monetary policy in a number of ways:
• Money creation...not making it but putting it into circulation
• Changing reserve requirements
• Changing the interest rates
• Purchasing bonds (open market operations)
2) Money creation
Banks keep a certain amount of funds on hand
• The required reserve ratio (RRR) is the amount that must be kept by
banks...this is established by the FED
• After the RRR is kept, banks can loan money. This process, along
with gained interest creates money...or adds it to the money supply
Banks may keep excess reserves on hand
• More money than is required by the RRR
3) Reserve Requirements
The FED can influence the economy by changing the RRR
Raising the RRR will reduce the money in circulation
Lowering it will increase the money in circulation
o Banks have more money to loan out
FED does not change the RRR very often
4) The Discount Rate
Banks borrow from the FED and the interest charged is known as the discount
rate.
In turn, these banks loan to customers and establish interest rates known as the
prime rate.
By changing the discount rate, the prime rate changes and affects spending
behaviors
Raising the discount rate will slow borrowing, spending and the economy
Lowering the discount rate will increase borrowing and spending, and
stimulate the economy
2nd most used form of Monetary Policy
5) Open Market Operations
• The most used monetary tool is open market operations
• This involves buying and selling bonds on open markets
• The FED will purchase bonds to put money into circulation
• They sell government bonds to take money out of circulation
6) Using Monetary Policy
Monetarism...the belief that the money supply is the most important factor in
macroeconomic performance
Money supply and interest rates
• In basic terms, the interest rate is the cost of money
• Works under the principles of supply and demand
• When money supply is high, interest rates are low
• When money supply is low, interest rates are high
7) Easy Money vs. Tight Money Policy
When money is in low supply, the FED may follow an easy money policy...or
follow policy that will increase the money supply
When money is in high supply, the FED will try to lower the money supply or use
tight money policy
8) Timing of Monetary Policy
Policies of Monetary Policy need to be carefully enacted to have the desired
effect...if they are not time accordingly, they may have a negative effect on the
business cycle.
Like with Fiscal Policy, Monetary Policy takes time to put in place and take
effect...lags
• Inside lag... Delay in implementing monetary policy
• The government takes time to recognize the problem and create a
solution
• Outside lag...the time it takes for the policy to have an effect
Predictions of the business cycle is key in this process