3/31 Monetary Policy

3/31 Monetary Policy

3 Tools of Monetary Policy used by the FED

• Reserve Requirement
• Open Market Operation - OMO
• Discount Rate

The FED sets the amount that banks must hold

Reserve Requirement Uses

1. recession; FED decreases reserve ratio
1. Banks hold less money and more ER
2. Banks create more money by loaning ER
3. MS increases, i decreases, AD increases
2. inflation; FED increases reverse ratio
1. Banks hold more money and less ER
2. Banks create less $
3. MS decreases, i increases, AD decreases

OMO - when FED buys/sells gov't bond; most important and widely used monetary policy

FED buys bonds - MS increases, FED sells bonds - MS decreases

Depends on whether the purchase or sale of bonds/securities if from bank or nonbank public entities

Discount rate - the interest rate that the FED charges commercial banks in the short-term

Federal Fund Rate - the FED Fund Rate is the interest rate that banks charge out one another for overnight loans