(Federal Open Market Committee) – the group within the fed that actually makes monetary policy & decides interest rates o 7 governors o 5 of the 12 district bank presidents o Only district bank president always in FOMC is the President of the District Bank of NY ▪ NY carries out the actual operations of borrowing/selling securities • Open Market Operations (OMO) o The Fed controls the size of the $ supply by conducting OMO – decreases or increases money supply by affecting the base o OMO – an exchange of commercial bank reserves for securities o Open Market Purchase ▪ The FED buys securities & pays for them by increasing bank reserves • Causes $ supply to rise • Fed is increasing bank reserves by placing $ in the bank’s reserve account o Open Market Sale ▪ FED sells securities and reduces bank reserves • Reduces the $ supply o OMOs as seen in T Accounts ▪ Open Market Purchase for Commercial Banks: Assets Liabilities Reserves + 20 Securities - 20 No Change! ▪ Open Market Sale for Commercial Banks: Assets Liabilities Reserves – 20 Securities + 20 No Change!
▪ Ex: $20 million Open Market Purchase. Reserve ratio of 10%. 3 Banks. Banks don’t want to hold excess reserves. Bank 1 Securities – 20 Loans + 20 No Change! Bank 2 Reserves + 2 Loans + 18 Deposits + 20 Bank 3 Reserves + 1.8 Loans + 16.2 Deposits + 18 Explanation: • Bank 1 sells $20 million in securities to the Fed and gains $20 million • Bank 1 deposits didn’t change, so it doesn’t have to hold any additional $ in reserves – free to loan out all of the $20 million • The person who received the loan deposits all the funds in to Bank 2 • Bank 2 has to keep $2 million in reserves (105) and is free to lend out $18 million to other people • Person who received the loan deposits all of the funds ($18 million) to Bank 3 • Bank 3 has to keep $1.8 million in reserves and can loan out $16.2 million • This money is loaned out again and again Final Sums: • Change in deposits of $200 million • Change in loans of $180 million • Net change in reserves of $20 million Finding These Sums: • If banks always hold rrr (required reserve ratio) of deposits as reserves, then in the long run... Reserves = rrr x deposits Deposits = Reserves x (1/rr) Change in deposits = (1/rrr) x change in reserves o This equation tells us how the fed controls the $ supply o Change in reserves is the same as change in base o Change in deposits is the change in MI Change in M1 = (1/rrr) x change in base 1/rrr = the simply money multiplier (mm) • Final equations: o Change in deposits = mm x change in reserves o Change in M1 = mm x change in base o M1 = mm x base ▪ Ex: Open Market Sale. Required reserve ratio of 10%. No currency. Bank 1 Securities + 20 Reserves – 20 Loans – 20 No Change! Bank 2 Reserves - 2 Loans - 18 Deposits - 20 Bank 3 Reserves – 1.8 Loans – 16.2 Demand Deposits - 18 Explanation: • The Fed sells $20 million of securities to Bank 1, so Bank 1’s reserves decrease by $20 million • Bank 1 has to reduce their loans by $20 million, so their reserves don’t have to change at all • Bank 2’s deposits decrease by $20 million. If it loses deposits, it no longer has to hold reserves
on those deposits. So, it’s reserve requirement drops by $2 million, so it reserves decrease by $2