Monetary Policy

Monetary policy- changes in the money supply to fight inflations or recessions.

What is monetary policy?

Open Market Operation Discount Rate Reserve Ratio

3 Monetary policies

The buying or selling of bonds to increase or decrease the money supply

Bond-fixed interest financial asset issued by governments, companies, banks, public utilities and other large entities

Open Market Operation

Money graph

An interest rate that commercial banks need to pay when they borrow a short term loan from the Fed.

Discount Rate

The fraction of total deposits kept on reserve by the bank.

These reserves cannot be used or be given out to customers unless the Fed changes the required reserve.

Required Reserve Ratio

An expansionary policy is used to fight a recession

An expansionary monetary policy will increase the money supply.

An increase in money supply will cause the velocity of money to go faster.

Expansionary Monetary Policy

Open market operation ◦ The Fed buys bonds from banks. ◦ The addition in the money supply will circulate the

economy.

Interest Rate/Discount Rate◦ Decrease in discount rate ◦ Increases excess reserves which expands money

supply

Required Reserve Ratio ◦ Decreasing the reserve ratio will ◦ Increases excess reserves

A Contractionary policy is used to fight off an inflation.

Decreases the money supply

Contractionary monetary policy

Open Market Operation ◦ The Fed sells bonds to commercial banks to

decrease the money supply. This happens because excess reserves drop.

Discount rate◦ Discount rate is increased to decrease excess

reserves

Reserve ratio ◦ Reserve Ratio is increased to lower excess

reserves

Inflation is an increase in the overall price level.

Unemployment is when labor is underutilized so production is not at its fullest.

Inflation and unemployment is seen as the output in an AS/AD graph

When do you need monetary policy?

Phillips curve

Recession and inflation graphs

Which is NOT a way that the Fed can affect the money supply?

A. A change in discount rate. B. An open market operation. C. A change in reserve ratio. D. A change in tax rates. E. Buying Treasury securities from

commercial banks.

Correct Answer- C

Ap questions

If the money supply increases, what happens in the money market? (Assuming money demand is downward sloping)

A. The nominal interest rates rises. B. The nominal interest rates falls. C. The nominal interest rate does not change. D. Transaction demand for money falls. E. Transaction demand for money rises.

Correct Answer-

Which of the following is a predictable advantage of expansionary monetary policy in a recession?

A. Decreases aggregate demand so that the price level falls.

B. Increases aggregate demand, which increases real GDP and increases employment.

C. Increases unemployment, but low prices negate this effect.

D. It keeps interest rates high, which attracts foreign investment.

E. It boosts the value of the dollar in foreign currency markets.

A likely cause of falling Treasury bond prices

A. might be expansionary monetary policy. B. contractionary monetary policy. C. a depreciating dollar. D. fiscal policy designed to reduce the

budget deficit. E. a decrease in the money demand.

Correct Answer- B

Expansionary monetary policy is designed

A. to lower the interest rate, increase private investment, increase aggregate demand, and increase domestic output.

B. lower the interest rate, increase private investment, increase aggregate demand, and increase the unemployment rate.

C. increase the interest rate, increase private investment, increase aggregate demand, and increase domestic output.

D. increase the interest rate, decrease private investment, increase aggregate demand, and increase domestic output.

E. increase the interest rate, decrease private investment, decrease aggregate demand, and decrease the price level.

Correct Answer- A