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1 MONETARY POLICY Lecture Notes #14 BA 315: Economy, Industry, and Competitive Analysis Source: Schiller Chapter 14 Edited by Ali Emami Department of Finance Charles H. Lundquist College of Business University of Oregon
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2 Introduction This lecture focuses on monetary policy. It reviews the structure and operations of the Federal Reserve System and analyzes the impact of Fed policies on aggregate demand. The purpose of this lecture is to provide answers to the following questions: 1. How does the government control the amount of money in the economy? 2. How does the money supply affect macroeconomic outcomes? Concepts you will learn Monetary Policy Discounting Money Supply (M1) Discount Rate Required Reserves Open Market Operations Excess Reserves Aggregate Demand Money Multiplier Aggregate Supply
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3 LECTURE OUTLINE I. Monetary Policy (Figure 14.1) f Definition: Monetary Policy – The use of money and credit controls to influence macroeconomic activity. II. The Federal Reserve System (Figure 14.2) A. Federal Reserve Banks - functions of 1. Clears checks between private banks 2. Holds bank reserves 3. Provides currency 4. Provides loans Monetary Policy AD A DETERMINANTS OUTCOMES Policy levers Monetary policy Internal market forces External shocks Output Jobs Prices Growth International balances Private banks (depository institutions) Federal Reserve banks (12 banks, 24 branches) Boar d o f Governor s (7 members) Structure of the Federal Reserve System
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4 B. The Board of Governors (Figure 14.2) 1. Key decision - maker for monetary policy. 2. Seven members appointed by President of U.S. for 14-year terms. C. The Fed Chairman 1. Most visible member of the Fed system. 2. Selected by the President for a four-year term. 3. Can be reappointed Example: President Reagan appointed Alan Greenspan. Greenspan was reappointed by President Bush and once again by President Clinton. His latest term will run into George W. Bush’s term. III. Monetary Tools A. Money Supply (M1) f Definition : Money Supply (M1) – Currency held by the public, plus balances in transaction accounts. B. The basic tools of monetary policy are: 1. Reserve requirements. 2. Discount rates. 3. Open-market operations. C. Reserve Requirements 1. Required reserves f Definition: Required Reserves – The minimum amount of reserves a bank is required to hold by government regulation; equal to required reserve ratio times transaction deposits. 2. By changing the reserve requirement, the Fed can directly alter the lending capacity of the banking system. 3. f Formula : multiplier money reserves excess system banking of capacity lending Available × = 4. Excess reserves a. f Definition : Excess Reserves – Bank reserves in excess of required reserves. b.
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