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The Toolbox of the Federal Reserve

The Toolbox of the Federal Reserve. Mr. Mizak Economics. Review. The Federal Reserve’s Purpose: Maintain financial stability through monetary policy How does the Fed control monetary policy? Through the use of multiple tools There is no magic wand that creates desired outcome.

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The Toolbox of the Federal Reserve

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  1. The Toolbox of the Federal Reserve Mr. Mizak Economics

  2. Review • The Federal Reserve’s Purpose: Maintain financial stability through monetary policy • How does the Fed control monetary policy? • Through the use of multiple tools • There is no magic wand that creates desired outcome

  3. Tool # 1- Change the Reserve Requirement • The Fed has the ability to change the reserve requirements for member banks. • The lower the reserve requirement, the more money that is available to loan. • The reverse is true as well • Very small changes in the RR can have drastic effects • Because of the drastic impact this tool is not often used

  4. Tool # 2- Changing the Discount Rate • When banks need money they have two options • 1) Borrow from the FED • The FED charges an interest rate known as the discount rate • Low discount rate= more money borrowed= more money in circulation • Reverse is true as well

  5. Tool # 3- Changing the Federal Funds Rate • When banks don’t borrow from the Fed, they borrow from other banks • Charged an interest rate known as the Federal Funds Rate • This rate is often lower than the discount rate • The Federal Funds Rate is the rate that is most often changed • Low FFR = more money borrowed = more money in circulation

  6. Current Data

  7. FFR- Historical Source: http://www.federalreserve.gov/releases/h15/data/Annual/H15_FF_O.txt

  8. Tool # 4- Open- Market Operations • The Fed can buy and sell government securities (Treasury bills, notes, and bonds) • When the Fed purchases gov. securities, it deposits money into the selling bank. • This deposit increases the bank’s reserves • Bank can lend more money • When the Fed sells gov. securities, it withdrawals money from the purchasing bank • This withdrawals decreases the bank’s reserves • Bank can lend less money

  9. Problems of Monetary Policy • No perfect solution • Despite availability of information, the Fed’s actions do not always have desired effect • The Fed has made bad economic situations worse • Has the Fed prevented more damage than it has caused?

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