AP Economics

Mr. Bernstein

Module 27: The Federal Reserve: Monetary Policy

February 19, 2015

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AP EconomicsMr. Bernstein

The Federal Reserve: Monetary Policy• Objectives - Understand each of the following:• The functions of the Federal Reserve System• The major tools used by the Federal Reserve System

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AP EconomicsMr. Bernstein

Functions of the Federal Reserve System• Provide Financial Services• “Banker’s Bank” and also US Treasury’s bank

• Supervise and Regulate Banking Institutions• Maintain Stability of the Financial System• Rationale behind providing liquidity to troubled entities

• Conduct Monetary Policy• One of most important functions• Often emphasized by AP exam

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AP EconomicsMr. Bernstein

The Fed’s Primary Policy Tools• Reserve Requirements• Increase in RR reduces amount of loans banks can

make, which reduces money supply • Banks face penalties for not maintaining adequate

reserves• Banks can borrow reserves from each other overnight

at Fed Funds market• Not used to actively manage money supply

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AP EconomicsMr. Bernstein

The Fed’s Primary Policy Tools• Discount Rate• Banks in need of reserves can also borrow from the Fed

directly via the Discount window• Discount Rate is the interest rate the Fed charges them• Normally the Discount Rate is set above Fed Funds rate

to discourage banks from accessing Discount window• Used primarily for liquidity needs and special situations

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AP EconomicsMr. Bernstein

The Fed’s Primary Policy Tools• Open Market Operations• Used to set Fed Funds rate and manage money supply• The New York Fed buys and sells Treasury Bills (short-

dated notes)• When they buy T-bills from a bank, this moves the

government’s debt from a bank to the Fed balance sheet, but importantly increases the cash at the bank, leading to an increase in money supply• In recent years, the Fed has engaged in QE, or buying

longer-dated bonds…has begun tapering this program