Monetary Policy and the Fed

Basic functions of the Fed

1) Regulating the Money Supply

2) Clearing checks

3) Advising gov on fiscal policies

4) Holding reserves (BIG ONE)

5) Supervising banks (BIG ONE)

The Federal Open Market Committee (FOMC)

Responsible for deciding policies the Fed should adopt to control the money supply (VERY POWERFUL)

The FOMC determines the…

Federal funds rate (range). This is the target interest rate commercial banks charge each other to borrow some of their reserve balances via overnight transfer

Monetary Policy

Involves changing the rate of growth of the supply of money in circulation in order to affect the cost of availability and credit

Loose/Expansionary Policy

Makes credit inexpensive and abundant. Might lead to inflation

Loose Policy Points

• Borrowing is easy

• Consumers buy more

• Businesses expand

• More people are employed

• People spend more

Tight/Contractionary Policy

Makes credit more expensive and in short supply in an effort to reduce inflation

Tight Policy Points

• Borrowing is difficult

• Consumers buy less

• Businesses postpone expansion

• Unemployment increases

• Production in reduced

Loose policy encourages _______ while tight policy controls ______

Growth, inflation

Basically, the Fed…

1) Keeps prices stable

2) Encourages stable maximum unemployment

NEW tools of the Fed

1) Open Market Operations - buying and selling bonds to increase/decrease monetary policy

2) Reserve Requirements - amount banks need to keep in reserve

3) Discount Window (NOW) - bank borrowing from the Fed and charging interest

Basically, the Fed now regulated ________ rather than _______ to change the _____________

Demand for money, supply of money, amount of money in the economy

Policy Implementation Tools:

1) Interest on Reserve Balances (IORB rate)

2) Overnight Reserve Repurchase Agreement Facility (ON RRP rate)

3) Discount Window (Discount rate)

4) Open Market Operations

Interest on Reserve Balances (IORB rate)

Primary tool. The interest rate that banks earn from the Fed on the funds they deposit in their reserve balance accounts

Overnight Reserve Repurchase Facility (ON RRP)

The ON RRP offering rate is an administered rate that acts like a reservation rate for a large number of financial institutions.