econ chapter 26
Terms in this set (25)
decisions are made by Congress and the president
Monetary policy is made by
the Federal Reserve System.
A central bank has many functions:
1. A central bank is a "banker's bank." It serves as a bank where commercial banks maintain their own reserves.
2. It performs service functions for commercial banks- Transferring funds and checks between various commercial banks in the banking system.
3. It typically serves as the major bank for the central government.
4. It buys and sells foreign currencies and generally assists in the completion of financial transactions with other countries.
5. It serves as a "lender of last resort" that helps banking institutions in financial distress.
6. It is concerned with the stability of the banking system and the money supply, which we know results from loan decisions of a bank.
In the United States, the central bank is 12 institutions, spread all over the country, closely tied together and collectively called the
Federal Reserve System.
The Fed has three major methods to control the supply of money:
Open market operations
2. Change reserve requirements.
3. Change its discount rate.
Of these three tools, the Fed uses open market operations the most.
Open market operations
involve the purchase and sale of government securities by the Federal Reserve System.
Open market operations are the most important method the Fed uses to change the supply of money.
1. It can be implemented quickly and cheaply—the Fed merely calls an agent who buys or sells bonds.
2. It can be done quietly, without a lot of political debate or a public announcement.
3. It is also a rather powerful tool, as any given purchase or sale of securities usually has an ultimate impact several times the amount of the initial transaction.(multiplier)
Velocity of money
represents the average number of times that a dollar is used in purchasing final goods or services in a one-year period.
The Reserve Requirement
The Fed possesses the power to change the reserve requirements of member banks by altering the reserve ratio.
Relatively small reserve requirement changes can have a big impact on the potential supply of money by changing the money multiplier.
The tool is so potent, in fact, that it is seldom used
Changes in required reserves and excess reserves have the potential to disrupt the economy
The Discount Rate
Banks having trouble meeting their reserve requirement can borrow funds directly from the Fed.
The interest rate the Fed charges on these borrowed reserves is called the discount rate.
If the Fed wants to contract the money supply, it will raise the discount rate, making it more costly for banks to borrow reserves
If the Fed is promoting an expansion of money and credit, it will lower the discount rate, making it cheaper for banks to borrow reserves.
The discount rate changes fairly frequently, often several times a year.
There seems to be some stigma among bankers about borrowing from the Fed; borrowing from the Fed is something most bankers believe should be reserved for real emergencies.
The discount rate's main significance is that changes in the rate signal the Fed's intentions with respect to monetary policy.
When banks have short term needs for cash to meet reserve requirements, they can take a very short-term (often overnight) loan from other banks in the
federal funds market.
The federal funds rate
is the interest rate charged in the federal funds market. It is the interest rate banks charge one another for overnight or short term borrowing. It is the Fed's target interest rate.
The Fed can do three things if it wants to reduce the money supply to prevent inflationary periods:
1. Sell bonds ;
2. Raise reserve requirements;
3. Raise the discount rate.
If the Fed is concerned about unemployment, recession, or a slowing/contracting economy it would increase the money supply
2. Lower reserve requirements;
3. Lower the discount rate;
The government could use some combination of these three approaches.
Equivalent expansionary fiscal policy actions
would be to reduce taxes, increase transfer payments, and/or increase government purchases.
The money market
is the market where money demand and money supply determine the equilibrium nominal interest rate.
People have three basic motives for holding money instead of other assets:
Transactions purposes - to facilitate exchange
Precautionary reasons - If unexpected medical or other expenses require an unusual outlay of cash, people want to be prepared
Asset purposes - money has a trait—liquidity—that makes it a desirable asset.
The Demand for Money:
the relationship between how much money people want to hold and the interest rate
At higher interest rates on other assets,
the amount of money (cash in your pocket) held will be smaller, because the opportunity cost of holding money will have risen.
The demand for money depends upon
income levels (the higher your income the more you spend)
the price level
Money market equilibrium occurs
at the nominal (your pay check dollars) interest rate where the quantity of money demanded equals the quantity of money supplied.
How Would an Increase in Money Supply affect Equilibrium Interest Rates and Aggregate Demand?
An increase in the money supply will shift the money supply to the right, lowering the nominal interest rate equilibrium.
The increase in the money supply causes the interest rate to fall in the short run. See figure A.
At lower interest rates, households and businesses invest more and buy more goods and services, shifting the aggregate demand curve to the right. See figure B.
Monetary policy actions can be conveyed through either the money supply or the interest rate.
A contractionary policy can be thought of as a decrease in the money supply or an increase in the interest rate.
An expansionary policy can be thought of as an increase in the money supply or a decrease in the interest rate.
Expansionary Monetary Policy:
An expansionary monetary policy to combat a recessionary gap results
There is a positive relationship between the money supply, the price level, the growth in the money supply, and the inflation rate.
Inflation - the rise in the overall price level, which decreases purchasing power of money
Hyperinflation - extremely high rates of inflation for a sustained period of time
YOU MIGHT ALSO LIKE...
Principles of Economics
Unit 6, Lesson 6
Macroeconomics Quiz 3
MacroEconomics Quiz Chapters 13/14
OTHER SETS BY THIS CREATOR
AGBU 2389, AGBU Bullion Exam 2, AGBU Exam 3
AGBU Exam 3
AGBU Bullion Exam 2
THIS SET IS OFTEN IN FOLDERS WITH...
Chapter 15 Economic Terms
Combo with "Ch. 13, 14 & 5 Quiz" and 2 others