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Monetary Policy in the United States

Monetary Policy in the United States

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  • Pyramid structure
  • 8 functions
  • 8 functions
  • Similar to accounting
  • This is set by the Fed
  • Standard simple balance sheet
  • Now the Fed can change macrobanks balance sheet as well as the money supply
  • Macrobank and Ecobank are sample banks
  • Relates to prior example
  • 2nd tool of the Fed
  • 3rd tool of the Fed.
  • Only if inflation is not a concern
  • Only if unemployment is not a concern.
  • 3 separate types of demand transactions and precautionary demand are stable. Asset demand changes with interest rate.
  • As IR goes up, Qm goes down.
  • As IR goes up, QM does not change
  • Direct- monetarists, Indirect – New Keynsians.
  • See textbook for more examples
  • See textbook for more details.


  • 1. And the Federal Reserve
    Monetary Policy
    By Tami Bertelsen
  • 2. The Federal Reserve
    Established in 1913 by Congress.
    Consists of 12 regional Federal Reserve Banks, 24 branch banks and hundreds of national and state banks.
    By Tami Bertelsen
  • 3. Primary Functions
    Supply the economy with fiduciary currency – supervises the printing of currency
    Provide a system for check collection and clearing
    Hold depository institutions reserve and sets the reserve requirement
    Act as the government’s fiscal agent – U.S. fiscal agent
    By Tami Bertelsen
  • 4. Primary Functions
    Supervise member banks
    Act as a lender of last resort
    Regulate the money supply
    Intervene in foreign currency markets to stabilize the value of the dollar
    By Tami Bertelsen
  • 5. Federal Reserve deposits
    Legal reserves – funds that depository institutions are allowed to claim as reserves
    Required Reserves – minimum amount of legal reserves.
    Excess Reserves = legal reserves minus required reserves
    By Tami Bertelsen
  • 6. Required Reserve Ratio
    The required reserve ratio is the percentage of total reserves that the Fed requires depository institutions to hold.
    By Tami Bertelsen
  • 7. Balance sheet
    The relationship between reserves and total deposits in depository institutions can be shown using a balance sheet.
    Assets – what is owned
    Liabilities – what is owed
    Net worth = assets – liabilities
    By Tami Bertelsen
  • 8. 8
    Example of a change in Balance Sheet - Starting Point
    By Tami Bertelsen
  • 9. 9
    Example of a change in Balance Sheet – Ending PointIf I write a check to you for $500,000, and you bank at Macrobank, a deposit of $500,000 comes into the bank.
    By Tami Bertelsen
    Note: This does not effect the overall money supply because they are just new reserves written from one bank to another. The Fed’s overall reserves remain the same
  • 10. Open Market Operations
    The Fed can make a direct effect on the overall level of reserves. The Fed buys and sells U.S. Government securities in the open market.
    By Tami Bertelsen
  • 11. Open Market Operations example
    By Tami Bertelsen
  • 12. Money Multiplier
    Actual change in money supply is equal to the actual money multiplier * change in excess reserves or 10*200,000=2,000,000 in our example.
    Gives the maximum change in the money supply due to a change in reserves. Mathematically it is equal to 1 / required reserve ratio. So, if the required reserve ratio is 10%, the multiplier would be 1 / 0.1 = 10.
    By Tami Bertelsen
  • 13. Discount rateis the interest rate that the Fed changes its Members for certain short-term loans.
    Lowering the discount rate Counteracts a recessionary trend by making it easier for banks to increase their reserve funds.
    Raising the discount rate Tends to counteract inflation by making it more difficult for member banks to increase their reserves.
    Discount Rate
    By Tami Bertelsen
  • 14. The Fed can change the percentage of depositor’s money that commercial banks are required by the Fed to keep on deposit in cash.
    Reserve Requirement Changes
    By Tami Bertelsen
  • 15. To expand money supply (during deflationary periods)
    1. Buy securities in the open market
    2. Lower the discount rate
    3. Lower reserve requirements
    By Tami Bertelsen
  • 16. To tighten money supply (during inflationary periods)
    1. Sell securities in the open market
    2. Raise the discount rate
    3. Raise reserve requirements
    By Tami Bertelsen
  • 17. Demand for Money
    By Tami Bertelsen
  • 18. Demand for money curveInverse relationship between the Interest rate and the Quantity of Money
    By Tami Bertelsen
  • 19. Money Supply CurveThe quantity of money is fixed at a given time and is vertical.
    By Tami Bertelsen
  • 20. Direct Effect
    Indirect Effect
    An increase in money supply leads directly to an increase in aggregate demand.
    When there is excess money, some people deposit it in banks. These funds are then converted to loans at a lower interest rate. When interest rates fall, planned investment rises. When investment falls, real GDP falls and aggregate demand increases.
    Money Supply increase effects on AD
    By Tami Bertelsen
  • 21. Aggregate Demand
    By Tami Bertelsen
  • 22. Shift in Aggregate Demand
    By Tami Bertelsen