Chapter 15 Monetary
Policy
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A. Transaction D, Dt results because people hold money, often in a money market account, to use as a medium of exchange.
B. Asset Demand, Da results because people accumulate money, often held in an investment account, to buy assets.
C. The demand for money, Dm= Dt + Dt
D For more information visit Demand for money - Wiki
A. Monetary policy is the regulation of the money supply to affect interest rates and economic activity.
B. It is part of, but not the focal point of Keynesian economics.
C. Objective is noninflationary full employment.
D. Affecting interest rates and to change investment thus affecting economic activity is one goal of the Fed.
1. Controlling reserve requirement may affect the money supply which may affect interest rates
a. Reserve requirement is the amount of demand deposits that must be kept in cash with the Federal Reserve or in the bank.
b. Often expressed as a percent called the reserve ratio.
c. Excess reserve can be loaned as demand deposits.
d. Excess reserves determine the potential money supply (M1).
2. Changes interest rates change investment causing a change in AD which changes economic activity.
a) Increasing the money supply may lower interest rates. increasing investment which increases AD which causes an increase
in Real GDP.
b) Decreasing the money supply may increase interest rates lowering investment which increses AD which causes an increase
in Real GDP.
3. Dollar values on this page are representative of amounts prevalent during the late 1990's (billions of dollars).
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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 individuals, businesses, and governments frees funds for spending.
c. Lower interest rates also decrease the international value of the dollar as investors buy (demand) other currencies to
earn more interest. The lower dollar increases XN as U.S. goods are less expensive and foreign goods more expensive.
2. Higher interest rates have an opposite affect
F. Federal reserve balance sheet
1. Assets are held in securities and loans to commercial banks.
2. Liabilities and net worth re the reserves of commercial banks, treasury deposits, federal reserve notes, and
equity(accumulated profits).
G. A Sokratic Dialogue: Liquidity Preference, Loanable Funds, and European Hedge Funds that Fear the Collapse of U.S. Treasury Bond Prices Brad DeLong
This article is very complex and not for the faint of heart. 6/18/11
A. Quantitative controls 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 contraction.
2. Open-market operations
a. Buying and selling of U.S. government bonds by the Federal Reserve from 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 reserves providing excess reserves banks can loan as
demand deposits.
2) When buying in the open market, increased demand from the Federal Reserve pushes up prices sellers receive,
lowering the effective interest sellers pay.
