I. The Demand for Money
A. Transaction 1, D1 results because people hold
money, often in
a money market account, to use as a medium of exchange.
B. Transaction 2 Asset Demand D2 results because people
often held in an investment account, to buy assets and
C. The demand for money, Dm= Dt + Dt
D. For more information visit
Demand for Money - Wiki
E. Affecting the non-investment components of aggregate demand
1. Lower interest rates also increase C, G, and XN
a. Consumption increases as credit purchases become cheaper.
b. Refinancing existing debt at lower interest rates by
and governments frees funds for spending.
c. Lower interest rates also decrease the international value of the dollar
investors buy (demand) other currencies to earn more interest. The lower
dollar increases XN as U.S. goods are less expensive
2. Higher interest rates have an opposite affect
3. Currency Exchange Rates and Economic Activity
a. Value of a currency determines price of import and export goods
b. Increase in money supply cause inflation lowering the value of currency
making exports cheaper and imports more expensive.
c. Exports increase as they are less expensive in real terms and imports
decrease as conversion to yen makes Toyota's more expensive
A strong Dollar is Always Good Except When It Isn't. 1/24/15
U.S Government's Problem With a Strong High Valued Dollar 2/5/15
A Brief History of U S Dollar Debasement 1/8/13
F. Federal reserve balance sheet.
1. Assets are held in
securities and loans to commercial banks.
2. Liabilities and net worth
are the reserves of commercial banks-
treasury deposits, federal reserve notes, equity-accumulated profits.
is the regulation of the money supply to
affect interest rates which
Average ratio to GDP of unsecured and
mortgage bank credit
Ratio of total mortgages to
of U.S. housing stock
Source: Jordà, Schularick, and Taylor (2016).
Bubbles Credit And Their Consequences
III. Types of
A. Quantitative affect the money supply.
1. Required Reserve Ratio
a. Lowering the reserve ratio creates excess reserves
which banks may loan
as newly created money. This is expansionary.
b. Raising the reserve ratio eliminates excess reserve so banks
can not renew
loans removing money and causing
a. Buying and selling of U.S. government bonds by the Federal
banks or in the open market to change
excess reserves thus affecting the
supply of M1 and interest rates is
the primary tool.
b. Buying bonds is expansionary.
1) When buying from banks, the Federal Reserve pays with
providing excess reserves banks can loan as
2) When buying in the open market, increased demand from the
Federal Reserve pushes up prices sellers receive, lowering the
effective interest sellers pay.
c. Selling bonds contracts the economy.
d. Review of
1) Suppose you buy a twenty year, $10,000 bond paying 5% per year
face value of $10,000. Face value is called par value.
a) A few years go by and you need money and one choice is to sell the
b) If interest rates on this type bond have gone down, people will be
anxious to buy, demand, will be
high pushing price up and you will receive
more than $10,000.
c) If rates have gone down, no one will give you $10,000, demand will be
so if you need the money, you will sell for less, below par.
d) You can hold for 20 years and get par.
2) Therefore, interest rates and bond values (prices) go in the opposite
If rates fall, old bond price rise as the old higher rate is attractive to
3) This is called the interest rate risk for bonds. Other risks have to
do with issuer
default and monetary inflation.
Open Market Committee minutes make interesting reading.
f. It is the most powerful of the four tools.
g. Historical Note on lender of last resort type actions before there was
bank began in response to the Panic of 1837 (U.S. first great
1. "The Secretary of the Treasury,
Chase, bought $13.5 million in
National 5-20 bonds, but this tepid
government response did little
to calm the markets (Juglar 95)." Tepid response would be used to
FED actions during Great Recession.
2. "The New York Clearing House had two tools at its disposal for combating
banking panics and liquidity crises, in the form of loan certificates and
3. Discount rate
a. This is the rate charged by the Federal Reserve for loans to member banks.
b. It strongly affects the prime
interest rate paid by a bank's best customers.
1) Lower the rate to expand economy as interest rates decrease.
2) Raise the rate to contract economy as interest rates increase.
3) Another important interest rate is the federal
funds rate which is the rate
at which banks loan funds to each other.
a. Initiated in 2007, it allows banks to add to their reserves at low rates.
b Done to increase bank liquidity which was low because of a loss in
caused by a housing crisis.
5. Adjusting to The Great Recession
How Fed Adjusted Tools to Combate Great Recession 1
How Fed Adjusted Tools to Combate Great Recession 2
B. Qualitative controls affect the actions of market participants.
1. Moral suasion or jawboning
a. This social pressure by influential
people to encourage specific people
to act in the public interest.
b. It is used to influence public opinion and political attitudes.
c. An example is when the Chairman of Board of Governors makes his
Report to Congress on the economy and
Margin Requirements, the down payment required on stocks which is
50%, is seldom changed.
Consumer Credit Controls credit cards work so well they are seldom used.
The Federal Funds Rate
a. Most controllable
b. Targeted by monetary policy
c. It is the overnight interest rate banks with excess fed reserve charge
short of fed reserve to keep the system in balance.
d. By controlling reserves, the fed controls this rate.
e. This allows them some control over short-term rates.
f. For more information visit
Federal funds rate - Wikipedia
g. Taylor rule
affected by Fed's
QE policies. 2/3/14
Taylor rule would have
kept millions out of work (Minneapolis
A Taylor Rule for Public Debt
Internet Game lets you be the FED chairperson.
D. Great Recession Brought New Tools
Easing unconventional increases the money supply
higher interest on bank excess reserves
a. Limits effectiveness of excess bank reserves
b. In creases bank liquidity of banking system
The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future
9 Facts About the Great Recession and tools for fighting the next downturn
Shrinking the FED' Balance Sheet/ 1/26/17
Relying o the FED's Balance Sheet 2/25/18
the money supply: with required reserve, open-market
operations, discount rate, term auction facility
Qualitative: affect financial
participation with moral suasion, margin requirements,
The Brave New World of Monetary Policy SF FED explains
resulting from the Great Recession 6/6/12
The Post Keynesian View-of Monetary Policy 12/10/15
Are The Effects Of Monetary Policy Asymmetric? Richman Fed 3/12/17
Implementing Monetary Policy
Elements Of Monetary Policy Implementation Framework 1 of 4
Counterparties And Collateral Requirements Of Implementing Monetary Policy
2 of 4
How Do Central Bank Balance Sheets Change In Times Of Crisis Part
3 of 4
The Trouble With Macroeconomics
centers on the failures of monetary policy
E. FED answers fiscal policy questions
What is the money supply? Is it important?
2. What are the Federal Reserve's objectives in conducting monetary
Why doesn't the FED just buy Treasury securities directly
from the U.S. Treasury?
4. Debt Monetization: Then And Now
Internet articles on difficulty of implementing monetary policy
V. Effectiveness of Monetary
1. Speedy and
isolated from political pressure
3. Hard money,
restrictive Federal Policy, has
worked well recently.
1. Easy money has
not worked well.
a. In the early 1900's, it didn't stop a recession.
b. Low profit expectations by business and fears
over possible employment loss by workers make
lower interest rates ineffective.
c. Interest rate cuts in 2001 were not able to stop
a recession as
borrowing as indicated by velocity slowed.
2. Bank deregulation has made
commercial banks a less
of investment funds thus diminishing
the effectiveness of monetary
3. Changes in money
velocity may negate some effects
of monetary policy.
4. Fall in real
interest rates increase demand for fixed assets.
Strengths: speedy, flexible, less political pressure,
works well controlling inflation but with pain
Weaknesses easy doesn't spur enough growth,
velocity adjusts to
counter reserve changes.
Hope FED is Prints
the Correct Amount
So Far So Good