Tools of Monetary Policy

I.            Tools:

            a.            Reserve Requirement

                                i.            FED sets the amount that banks must hold to control the amount of money that may be loaned out.

                              ii.            When someone deposits, the bank deposits in the bank it loans out excess reserves.

                           iii.            Except for FED purchase of bonds. None of the FED money needs to be reserved.

                           iv.            In recession, FED lowers rrr to enact expansionary policy. Money supply & AD increase while interest rates descend.

                              v.            In inflation, FED raises rrr to enact contractionary policy. Money supply & AD decrease while interest rates augment.

            b.            Open Market Operations

                                i.            My name is Bund, James Bund

                              ii.            OMO is the FED transactions of government bonds or securities.

                           iii.            Most used policy.

                           iv.            Buying bonds puts money in the banks and increases money supply.

                              v.            Selling bonds takes money from the banks and decreases money supply.

                           vi.            Bonds to banks have no rrr. Bonds to individuals have rrr.

             c.            Discount Rates

                                i.            Many different interest rates that flow together up and down.

                              ii.            Federal funds rate is the interest rate that banks charge one another for overnight loans.

Money Market Video