APMACRO 4.4-4.6

Money multiplier

1/Required reserve ratio

Required reserves

• The portion of deposits that banks must keep and cannot lend.

• Set by the central bank.

Excess reserves

• Any reserves banks hold beyond the required amount.

• Can be lent out to create more money.

Monetary policy tools in a limited reserve banking system

• Open Market Operations: Buying/selling bonds changes reserves.

• Discount Rate: Interest rate for bank loans from the Fed.

• Reserve Requirements: Changing required reserves affects lending.

Monetary policy tools in an ample reserve banking system

• Focus on interest on excess reserves (IOER) to control rates.

• Open market operations mainly influence short-term interest rates, not the total money supply.

Money Market graph

• Shifts in Money Demand:

  • ↑ Income → ↑ Money demand → Interest rates ↑

  • ↑ Prices → ↑ Money demand → Interest rates ↑

  • ↓ Income or prices → ↓ Money demand → Interest rates ↓

• Shifts in Money Supply:

  • Central bank buys bonds → Money supply ↑ → Interest rates ↓

  • Central bank sells bonds → Money supply ↓ → Interest rates ↑

Shifts of Money Supply and Money Demand curves

• Money Supply ↑: Interest rates ↓

• Money Supply ↓: Interest rates ↑

• Money Demand ↑: Interest rates ↑

• Money Demand ↓: Interest rates ↓

Bank assets and liabilities

• Assets: Loans, reserves, securities

• Liabilities: Deposits, borrowed funds

• Banks use deposits (liabilities) to fund loans (assets).

Impact of interest rates on investment, consumption, AD, and GDP

• Interest rates ↓ → Investment ↑, Consumption ↑ → Aggregate Demand ↑ → GDP ↑

• Interest rates ↑ → Investment ↓, Consumption ↓ → Aggregate Demand ↓ → GDP ↓

Discount Rate

This is the rate that the Fed charges banks for loans

Fed Funds Rate

This is the rate that banks charge each other for overnight loans

Prime Rate

This is the rate that banks charge their best customers