Class 15 - Econ 350 U.S Financial Systems Markets and...

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Econ 350 U.S. Financial Systems, Markets and Institutions Class 15 Econ 350 U.S. Financial Systems, Markets, and Institutions Class 15: Reserve Markets and the Tools of Monetary Policy Welcome back! In today’s class, we extend the discussion of the tools of monetary policy that we began in the last class, and show how changes in these tools can affect the market for reserves. Remember that the tools of monetary policy are open market operations, discount rates, and reserve requirements. As we showed in the last class, changes in reserve requirements affect the money multiplier, while changes in open market operations or discount loans influence the monetary base. We now show how these monetary policy tools can affect the market for reserves and the federal funds rate. Course Objectives After today’s class, you should -- understand the tools of monetary policy and how they affect reserve markets. -- know the components of the demand for reserves. -- know the components of the supply of reserves, and understand its shape. -- be able to distinguish between the federal funds rate and the discount rate. -- understand how the federal funds rate adjusts to equate the demand for reserves and the supply of reserves. -- know how open market operations affect the market for reserves. -- know how a change in the discount rate affects the market for reserves. -- know how a change in reserve requirements affects the market for reserves. -- understand how the NY Fed maintains a target for the federal funds rate. Tools of Monetary Policy To review, the tools of monetary policy are: 1. Open market operations. Through the purchase or sale of securities to banks or the public, the Fed can affect the quantity of non-borrowed reserves (R N ) held in the banking system. An open market purchase increases reserves, while an open market sale depletes reserves. Changes in the quantity of non- borrowed reserves (R N ) lead to changes in the supply of reserves and the monetary base. 2. Discount rate. Changes in the discount rate (i d ) lead to changes in the amount of discount loans (DL) taken by banks. An increase in discount loans, for example, will increase the supply of reserves and the monetary base. 3. Reserve Requirements. A change in reserve requirements affects the money multiplier. If there is an increase in the required reserve ratio (r), then banks must hold more of their assets in required reserves, so less will be available for lending and deposit creation. Reserve requirements affect the demand for reserves. 131
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Econ 350 U.S. Financial Systems, Markets and Institutions Class 15 The Monetary Base The monetary base can be measured in two ways. First we can measure the monetary base as the sum of currency plus reserves. MB = C + R Secondly, we can measure the monetary base as the sum of the non-borrowed monetary base and discount loans.
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