By affecting AD eg US is in recession Refer to Graph 14 Suppose US is in

By affecting AD e.g. U.S. is in recession ****Refer to Graph 14Suppose US is in recession at Pt. A, y < y barFed’s objective is to shift AD back to AD, How? Fed controls the MS and therefore it

Money Market (M1) Md – demand for M1 for transactions Assume: HH’s hold a portfolio of assets that include only : - Money (M1) earns zero interest - Bonds – loan interest Bonds – are financial securities sold by corporations and governments to help finance their operations e.g. US Treasury bonds finance the government deficit Deficit = (Tax Revenues – Government Expenditures) < 0 Investors buy bonds because they earn interest annually. e.g. 1 year bond for $1000 at 0.50%. When bond matures at end of year investor receives: Principle $1000 + Interest .005 x 100 5 1005 ****Refer to Graph 15 The opportunity cost of holding M1 is the interest … could earn on a bond. As interest rates increase from 1% to 5%, MD decreases from $1000 to $900 ****Refer to Graph 16 MS is controlled by the Fed. It is set at the amount necessary, e.g. $950 for y = y bar ****Refer to Graph 17 4/11 : ****Refer to Graph 18 [money market] How does the Fed increase MS? - Engineers open market purchase (OMP) Treasury bonds from investors in the bond market  Investors receive checks from the fed  Investors will deposit their checks in their deposit accounts at local bank and a multiplier process occurs (see last class notes)  MS shifts right How does the Fed decrease MS?

AD = C + I + G + NX (AD, C, and I increase) AD shifts back to the right - See Fig. 1 4/16 : US in recession Fed engineers omP => decreased i => increased C, increased I OMP => Expansion of deposits, i.e. multiplier process kicks Change in D = m x change in TR Change in TR = OMP = $10 billion rr = 0.10 $100 billion = 1/.10 x 10 billion OMP to bring US out of recession is AKA: - Expansionary/simulative monetary policy Transmission Mechanism – the mechanism that links monetary policy actions to the financial system and ultimately inflation (price level) and real GDP