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Chapter 12 Monetary Policy

Chapter 12 Monetary Policy. Chapter Outline. GOALS, TOOLS AND A MODEL OF MONETARY POLICY CENTRAL BANK INDEPENDENCE MODERN MONETARY POLICY. The Federal Reserve. Nicknamed “The Fed ”. Established in 1913 by Congress primarily as the authority for bank regulation .

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Chapter 12 Monetary Policy

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  1. Chapter 12Monetary Policy

  2. Chapter Outline GOALS, TOOLS AND A MODEL OF MONETARY POLICY CENTRAL BANK INDEPENDENCE MODERN MONETARY POLICY

  3. The Federal Reserve • Nicknamed “The Fed”. • Established in 1913 by Congress primarily as the authority for bank regulation. • The power to “coin money” • The power to regulate the supply of money in the economy • This power allows the Federal Reserve to alter interest rates without political interference. • There are 12 regional Federal Reserve Banks Boston, New York, Philadelphia, Richmond, Atlanta, Cleveland, St. Louis, Kansas City, Chicago, Dallas, Minneapolis, and San Francisco

  4. Goals of Monetary Policy • Provide sufficient money to the economy so that it may grow at a sustainable rate. • Dampen the impact of recessions • Control Inflation

  5. Measures of the Money Supply • Monetary Aggregate: a measure of the quantity of money in the economy • Components of the money supply • M1 =cash+coin, checking accounts, travelers checks • M2=M1+saving accounts+ small CDs

  6. The Banking System • When a bank takes a deposit into an account on which a check can be written, it must place a percentage of that deposit on reserve at a Federal Reserve bank. That percentage is called the reserve ratio.

  7. The Tools of Monetary Policy • Open Market Operations • The Fed buys US government debt in order to get cash into the economy. • The Fed sells US government Debt in order to get cash out of the economy. • More money in the economy puts downward pressure on interest rates. • Targeted Interest Rates • The Fed directly controls the percentage of deposits that banks must have at their regional Fed bank. • Reserve Ratio • The Fed directly controls the percentage of deposits that banks must have at their regional Fed bank.

  8. Interest Rates Price Level S AS S’ r r’ AD2 D AD1 Loanable Funds RGDP Expansionary Monetary Policy

  9. Interest rate Price Level S’ AS S r’ r AD1 AD2 D Loanable Funds RGDP Contractionary Monetary Policy

  10. Central Bank Independence • Countries with Central Banks that are more independent of political control have higher rates of economic growth. • This is because political influences tend to create inflationary tendencies which raises interest rates and lowers long-term investment.

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