Lecture 15_Chapter 18

Lecture 15_Chapter 18 - Chapter 18 Tools of Monetary Policy...

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1 Chapter 18 Tools of Monetary Policy Using Interest Rates to Stabilize the Domestic Economy Monetary Policy & Interest Rates: The Big Questions 1. What are the tools used by central bankers to meet their stabilization objectives? 2. How are the tools linked to the central bank’s balance sheet? 3. How is the interest rate target chosen? The Fed can control the MB but cannot precisely control the Money Supply M1 = m x MB 1+{ C / D } M1 = MB r D + { ER / D } + { C / D } Households can change C/D, causing the money mutiplier ( m) and M1 to change Banks can change ER/D, causing m and M1 to change
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2 Tools of Monetary Policy 1+{ C / D } M1 = (C + R) r D + { ER / D } + { C / D } Increase/decrease Reserve Requirement Increase/decrease the cost for banks to borrow reserves Increase/decrease MB The Fed’s “Old/Traditional” Monetary Policy Toolbox Open Market Operations - OMO . Discount Rate - the interest rate the Fed charges on the loans it makes to banks Reserve Requirement - the level of balances a bank is required to hold either as vault cash on deposit or at a Federal Reserve Bank The primary instrument of monetary policy is the Federal funds rate: the interest rate on overnight loans of reserves from one bank to another A New (fourth) Tool Interest on reserves - required and excess Currently set at 0.25% The Financial Services Regulatory Relief Act of 2006 authorized the Federal Reserve to begin paying interest on reserve balances of depository institutions beginning October 1, 2011. The Emergency Economic Stabilization Act of 2008 accelerated the effective date to October 1, 2008.
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3 Open Market Operations: Impact on Reserves Federal funds are reserve balances that depository institutions can lend to one another. The most common federal funds transaction is an overnight, unsecured loan between two financial institutions. (bilateral agreements) Note that without the FF market, banks would need to hold a substantial amount of excess reserves. Open Market Operations
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This note was uploaded on 12/21/2011 for the course 1 1 taught by Professor 1 during the Spring '11 term at Université de Moncton.

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Lecture 15_Chapter 18 - Chapter 18 Tools of Monetary Policy...

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