Monetary Policy

Monetary PolicyMonetary Policy – the gov't ability to control

the supply of money and Credit to stabilize the economy

The Federal Reserve controls Monetary Policy

Federal Reserve System Structure 12 Reserve Banks

BostonBostonNew YorkNew York

PhiladelphiaPhiladelphia

ClevelandCleveland

RichmondRichmond

ChicagoChicago

St. LouisSt. Louis

Kansas CityKansas City

MinneapolisMinneapolis

San FranciscoSan Francisco

DallasDallas

AtlantaAtlanta

12

12

Federal Reserve (FED)The Federal Reserve is the central banking

system for the United States If the commercial “baby” banks (Bank of

America, Wachovia) need money they go to the Federal Reserve.

Federal Reserve tells the baby banks what to do.

3 Tools used in Monetary PolicyDiscount Rate

Reserve Requirement

Open Market Securities (Bonds)

Reserve RequirementThe amount of money that “baby”

banks must keep in their vaults at the end of the day.

This requirement is set by the FED. Usually around 10%.

When money is deposited in a bank, the bank is allowed to lend or invest part of that deposit. But it must keep part of the deposit in "reserve."

Reserve RequirementBank # New Deposits 10% Fractional

ReservesLoans

1 $1,000.00 $100.00 $900.00

2 $900.00 $90.00 $810.00

3 $810.00 $81.00 $729.00

4 $729.00 $72.90 $656.10

5 $656.10 $65.61 $590.49

Discount (Interest) rateThe interest rate the Fed charges a

commerical bank if it needs to borrow money to loan to customers.

The “Fed” loans money to banks at an interest rate that the Fed decides.

Open Market SecuritiesBonds the “Fed” buys and sells

The “Fed” can sell bonds to the baby banks

or buy bonds from the baby banks

Monetary Policy

Slow Economy(Inflation)

GrowEconomy(Recession)

Increase Reserve Requirement

Increase Discount Rate

Sell Securities

Decrease Discount Rate

Buy Securities

Decrease Reserve Requirement