monetary policy

• What is money?


  The sets of all assets that are regularly used to directly purchase goods and services
• Three Main Functionsof Money


  A Store of Value, Medium of Exchange(Barter), Unit of Account
• A Unit of Account

  A Standard Unit of Comparsion
• What makes for good money?

  Stability of Value and Convience
• Commodity-Backed Money


  any form of money that can be legally exchanged into a fixed amount of an underlying commodity
• Example of Commodity Backed Money

  anyone could go to a designated “reserve bank” and exchange those dollar bills for a fixed amount of gold, bank was required to accept exchange
• What is the con of commodity-backed money?


  It has a resource cost
• Fiat Money


  money created by rule, nothing tangible to back it
• What kind of exchange happens when people trade goods without using money?

  overall economic activity would fall, trading slows to a halt
• Fractional-Reserve Banking


  Fractions of Deposits in Banks
• Demand Deposits


  Funds held in bank accounts that can be withdrawn at any time by depositors
• How is cash an asset and liability for banks?

  • A resource that the bank possess
  • An amount the bank owes
• Required Reserves


  the minimum fraction of deposits that banks are legally required to keep on hand
• Excess Reserves


  any additional amount, beyond the required reserves, that a bank chooses to keep in reserve
• Money Multipler


  ratio of money created by the lending activities of the banking system to the money created by the government’s central bank

  $1/reserve ratio(rr)$
• M1 


  currency held by the public plus checking account balances
• M2


  M2 includes everything in M1 plus savings accounts and other financial instruments where money is locked away for a specified period of time
• Monetary Policy


  actions by the central bank to manage the money supply
• What variables in AD does monetary policy affect when changing interest rates?

  Consumption and Investment
• What is the dual mandate of the Fed?

  Using monetary policy to ensure price stability and to maintain full employment
• What are the three traditional options of how the Fed changes monetary supply?

  • Reserve Requirements
  • The Discount Window
  • Open-Market Operations
• What is the most powerful tool to the Fed?

  Adjusting the Reserve Requirement
• Why is the Reserve Requirement rarely used?

  Too powerful, can be big change and send ripple effects through the economy
• What is the discount window?

  Lending facility that allows any bank to borrow reserves from the Fed
• What is the discount rate?


  the interest rate charged by the Fed for loans of reserves through the discount window
• Why are discount windows are rarely used for monetary policy?

  Discount rates are somewhat higher than interest rates available in the market so banks look for other interest rates
• What are Open Market Operations(OMO's)

  sales or purchases of government bonds to/from banks on the open market
• Why does OMOs directly affect the money supply?

  To increase the money supply, it can purchase a bond from one of the large banks it trades with to fill its reserve. decrease the money supply, it can sell bonds.
• What are ways of expansionary monetary policy?

  Buying Bonds, lower interest rates
• What are ways of contractionary monetary policy?

  Increase interest rates, selling bonds
• Why is selling bonds considered contractionary monetary policy?


  The bank pays for the bonds with money that it keeps on deposit at the Fed. The sale thus reduces the bank’s reserves and sends ripple effects
• Federal Funds rate

  The interest rate at which banks choose to lend reserves held at the Fed to one another
• Zero Lower Bound


  Natural Lower Limit on Interest Rates(like cold hard cash)
• What is money demand?

  ease of turning assets into cash, dictated by the amount of stuff people want to buy
• What is money supply?

  the supply of money is considered to be set only by the Federal Reserve
• What will shift the money supply curve to the right?

  decreasing the reserve requirement, decreasing the discount rate, or buying government bonds
• What are shifters of money demand?

  Price Level, Incomes, Technology