The Federal Reserve and Monetary Policy

Flashcards for Chapter 16: The Federal Reserve and Monetary Policy

Federal Reserve System

The central bank of the United States, created by Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system.

Monetary Policy

The macroeconomic policy laid down by the central bank involving management of money supply and interest rates to achieve macroeconomic objectives.

Money Supply

All the money available in the United States economy.

M1

Money that people can gain access to easily and immediately to pay for goods and services (highly liquid).

Components of M1

Currency and demand deposits (checking accounts).

M2

All of M1 plus funds that can be converted to cash fairly easily.

Components of M2

Savings accounts, certificates of deposit (CDs), and money market accounts.

Open Market Operations

Buying/selling government bonds to expand/contract the money supply.

Discount Rate

Primarily the decision of the Chairman of the Federal Reserve Board.

Reserve Requirement Ratio (RRR)

Amount of deposits banks must keep in reserve (rarely ever used).

Expansionary Policy

Grows the economy but may cause inflation to go up; lowers the discount rate and buys bonds from investors.

Contractionary Policy

Controls inflation but may cause economic growth to slow; raises the discount rate and sells bonds to investors.

Inside Lag vs. Outside Lag

Lags in the effect of monetary policy on the economy.

Easy Money

Monetary policy that increases the money supply.

Tight Money

Monetary policy that decreases the money supply.