1. AP Macroeconomics Monetary Policy

2. Institutions that Carry out Monetary Policy • Central bank (The US Federal Reserve, Bank of Japan, European Central Bank, Bank of England…)

3. Goals of Monetary Policy and the Institutions • efforts to promote: • Full employment • Price stability • Long-run economic growth

4. How do central banks try to achieve their goals? • They control the money supply and interest rates.

5. My name is Ben Bernanke. I am the Federal Reserve Chairman. I help to enact Monetary Policy.

6. Ben Bernanke here again. The Fed enacts Monetary Policy by manipulating the money supply. PS Mr. Bharucha is the best!

7. Expansionary (Easy Money) Monetary policy designed to counteract the effects of recession and return the economy to full employment. Contractionary (Tight Money) Monetary policy designed to counteract the effects of inflation and return the economy to full employment. Types of Monetary Policy

8. Tools of Monetary Policy • These are the items the Fed can change to enact MP. They will be defined and discussed later in the notes. • Required Reserve Ratio • The Discount Rate • Open Market Operations (OMO)

9. All that is necessary for the triumph of evil is that good men do nothing. --Edmund Burke

10. The Required Reserve Ratio • The US runs on a fractional banking system. • That means that a portion of all demanddeposits must be stored as cash IN the bank (vault cash) or… • Kept on reserve as Federal Funds in the bank’s account with the Fed. • Either way, this money stored as cash or in an account with the Fed can NOT be loaned out.

11. Required Reserve Ratio (cont) • There are two types of reserves: • Required—the money that the bank HAS to have on hand or on reserve in the bank’s account with the Fed. • Excess—all other demand deposits. • The bank can NOT loan out required reserves. • The bank IS ABLE to loan out excess reserves. • Excess Reserves=Actual Reserves-required reserves

12. Federal Funds Rate • The Fed Funds rate is the interest % banks pay each other for overnight loans of Federal Funds • As we go through this remember that each member bank HAS TO have a certain percentage of deposits in required reserve.

13. Why do banks need overnight loans? • Banks are like any other business in that they seek to maximize profits. How do banks make profit? • Banks make a profit by loaning out as much of their excess reserves as possible and charging interest to the borrower. • What if they’ve loaned out too much and they don’t have enough “in reserve”??? • Dun-Dun-Dun!!! • Then they’ll need to get some cash—fast!

14. Why do banks need overnight loans? (cont) • If, in the course of business, banks have loaned out more than their excess reserves and do not have enough money to satisfy the required reserve ratio… • They must get the cash, quick. • How do banks get cash quick?

15. How do banks GET overnight loans? • They can borrow from another bank. • They can borrow from another bank that has excess reserves to loan out. • If the bank goes to another bank to borrow money, they are using the Federal Funds market.

16. Federal Funds Rate • Why would one bank loan out money to another bank? • Correct, profit. • What do banks charge on a loan to make profit? • Correct, interest. • The Federal Funds Rate is the interest rate banks charge each other for overnight loans