Study guide ECON 120

Study guide ECON 120 - 14 The Federal Reserve and Monetary...

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14 The Federal Reserve and Monetary Policy Chapter Summary In this chapter, you’ll learn about the role of the Federal Reserve in conducting monetary policy. In the short run, the Federal Reserve can influence interest-rate levels in the economy by changing the money supply. Money markets determine interest rates in the short run. When the Federal Reserve lowers interest rates, investment spending and GDP increase because the cost of funds is cheaper. Here are the main points of the chapter: The demand for money depends negatively on the interest rate and positively on the level of prices and real GDP. The Fed can determine the supply of money through open market purchases and sales, changing reserve requirements, or changing the discount rate. Open market operations are the primary tool the Fed uses to implement monetary policy. The level of interest rates is determined in the money market by the demand for money and the supply of money. To increase the level of GDP, the Federal Reserve buys bonds on the open market. To decrease the level of GDP, the Federal Reserve sells bonds on the open market. An increase in the money supply will decrease interest rates, increase investment spending, and increase output. A decrease in the money supply will increase interest rates, decrease investment spending, and decrease output. In an open economy, a decrease in interest rates will depreciate the local currency and lead to an increase in net exports. Conversely, an increase in interest rates will appreciate the local currency and lead to a decrease in net exports. Both lags in economic policies and the need to influence market expectations make successful monetary policy difficult in practice. Applying the Concepts After reading this chapter, you should be able to answer these three key questions: 1. What happens to interest rates when the economy recovers from a recession? 2. Is it better for decisions about monetary policy to be made by a single individual or by a committee?
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202 Chapter 14 3. What are the advantages and disadvantages of the Federal Reserve becoming more transparent about its actions and decisions and disclosing more information to the public? 14.1 The Money Market To understand how interest rates are determined in the short run, we need to understand the money market. The money market is the market for money where the amount supplied and the amount demanded meet to determine the nominal interest rate. We begin by studying the factors that determine the public’s demand for money. Once we understand what affects the demand for money, we can see how the actions of the Federal Reserve determine the supply of money. Then we’ll see how the demand and supply of money together determine interest rates. There are various reasons people demand money balances. Changes in interest rates, prices, and real
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This note was uploaded on 10/25/2009 for the course ECON 81509 taught by Professor X.song during the Spring '09 term at Mesa CC.

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Study guide ECON 120 - 14 The Federal Reserve and Monetary...

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