Key Concepts
#1 Reserve Requirement - Only a small % of your bank deposit is in the safe. The rest of your money has been loaned out.
- Called "Fractional Reserve Banking" -
FED sets amount banks must hold -RR is the % of deposits that banks must hold in reserve and NOT loan out -FED increases the MS it Increases the amount of money held in bank deposits
1)Recession - what should FED do to RR? -Decrease the RRatio banks hold less money more ER banks create more money loaning out excess MS increases, interest rate fall, AD increases
2)Inflation - Banks hold more money less ER banks create less money MS decreases, interest rate increases, AD decreases
#2 Discount Rate - is the interest rate that the FED charges commercial banks
-To increase the MS, the FED should decrease the discount Rate (Ex:Monetary Policy)
-To decrease the MS, the FED should increase the Discount Rate (Ex:Tight Money Policy)
#3 Open Market Operations (OMO)
-FED buys/sells gov't bonds (securities)
-This is money important and widely used monetary policy
-Increase the MS FED should BUY gov't securities
-Decrease the MS FED should SELL gov't securities
To add a little more details of when the FED buys government securities in expansionary monetary policy, it means it deposits the payment into the bank accounts of the banks, businesses, and individuals who sold the securities which will increase the money supply. If it was in contractionary monetary policy, the FED will sell government securities and buyers will pay from their bank accounts which causes a decrease in money supply.
ReplyDeleteYou may also want to take note that when a customer deposits or withdraws cash from their account (check-able) it has no effect on money supply. It only changes the composition of money, excess reserves, and required reserves.
ReplyDeleteI would like to add that the crowding out effect occurs when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending.
ReplyDelete