Unformatted text preview: f money
moves to the left and the interest
rate falls. This discourages
investment and interest-sensitive
consumption, which decreases the
aggregate demand. Price levels fall
while real output decreases. Dm
Q3 Q1 $ of M The Money Market 75 Relative Importance:
√ Central bank borrowing by commercial banks at discount rate is very small (2 to
3%), mostly in response to open market operations involving buying and selling of bonds. It is a
passive form of monetary policy.
√ The effectiveness of the discount rate as a tool depends on the initiative of the
commercial banks to increase reserves and make loans.
√ Changes in the reserve requirement is rare since it has immediate effects on the cash
balances held by the FED for commercial banks; this can lower profit if the rate is increased.
√ The use of open market operations is the quicker tool to use and the method that
has also immediate effect.
Targeting Federal Funds Rate
The FOMC can influence the Federal Funds Rate, which is an interbank overnight rate.
An equilibrium interest rate is created when banks borrow from each other overnight to cover
their required reserve amounts. The funds are called “Federal Funds” because they are reserves
that are required by the FED. The FED is the only supplier of the currency used by banks. In
today’s money markets, the Federal Open Market Committ...
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- Fall '11
- Monetary Policy, Federal Reserve System, Fed, federal funds rate, excess reserves