Monetary Policy Monetary Policy reviewreview

huh???? can you break it huh???? can you break it downnnnn???downnnnn??? Monetary policy – Monetary policy – things the Federal things the Federal

Reserve does to regulate the economy Reserve does to regulate the economy & influence the rate of inflation by & influence the rate of inflation by increasing or decreasing the money increasing or decreasing the money supplysupply

the actions will depend upon where in the actions will depend upon where in the business cycle the economy is…..the business cycle the economy is…..

A period of A period of contractioncontraction (recession) (recession)

- means that the economy has - means that the economy has slowed slowed way down way down

– – unemployment is high, people unemployment is high, people aren’t aren’t spending or borrowing spending or borrowing money, the money, the economy is not economy is not growinggrowing

What will the Fed want to do?What will the Fed want to do? when the economy is in a when the economy is in a recessionrecession

(contraction) the Fed will want to (contraction) the Fed will want to increase the money supply to get increase the money supply to get the economy moving & growing the economy moving & growing againagain

How do they do thattttt????????How do they do thattttt????????

Easy Money policy!!Easy Money policy!!

1. decrease the discount (interest) rate1. decrease the discount (interest) rate

this encourages people to take out this encourages people to take out loansloans

which increases the amount of which increases the amount of money in money in circulation!circulation!

2. Reduce the reserve requirements2. Reduce the reserve requirements

when banks have to keep less money when banks have to keep less money in reserves, they can lend more money in reserves, they can lend more money outout

……which increases the amount of money in which increases the amount of money in circulation!circulation!

3. “Open market operations” – buy 3. “Open market operations” – buy government bondsgovernment bonds

the Fed buys the bonds using Federal the Fed buys the bonds using Federal Reserve fundsReserve funds

………….. which increases the amount of .. which increases the amount of money in money in circulation!circulation!

Oh…..I get it!!! ……..but what about…..Oh…..I get it!!! ……..but what about…..

A period of A period of expansionexpansion

- means that the economy has been - means that the economy has been steadily steadily growinggrowing

- interest rates are high, unemployment - interest rates are high, unemployment is is lowlow

- inflation – prices increasing- inflation – prices increasing

……so…what will the Fed do nowwww??so…what will the Fed do nowwww??

when the economy is in an expansion, when the economy is in an expansion, the Fed will want tothe Fed will want to decrease the decrease the money supply to slow the economy money supply to slow the economy down and reduce inflationdown and reduce inflation

……..how…..??????..how…..??????

Tight Money policy!!Tight Money policy!!

1. Increase the discount (interest) rate1. Increase the discount (interest) rate

this will discourage people from this will discourage people from taking out loans, which will decrease taking out loans, which will decrease the amount of money in circulationthe amount of money in circulation

2. Increase the reserve requirements2. Increase the reserve requirements

banks will have to keep more money banks will have to keep more money in reserves, and will have less money in reserves, and will have less money to lend outto lend out

…….which will decrease the amount of .which will decrease the amount of money in circulationmoney in circulation

3. “Open market operations – sell 3. “Open market operations – sell government bondsgovernment bonds

the money received for the bonds is the money received for the bonds is taken out of the markettaken out of the market

…….which decreases the amount of money .which decreases the amount of money in circulation!in circulation!