ECON202 AMPLE RESERVES

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What are the 2 key administered rates that the FED now uses to drive the Fed Funds Rate into the target range?

The two key administered rates are the Interest on Reserves (IOR) and the Overnight Reverse Repurchase Agreement rate.

Can you explain how the FED’s use of 3 administered rates changes the shape of the Demand curve for reserves?

The use of three administered rates helps to set a lower bound for the demand for reserves, effectively making it more elastic as banks adjust their reserve holdings in response to changes in these rates.

Can you explain how the FED changing its administrative rates will naturally change the reservation rate for banks and lead to arbitrage that will drive the FFR into the new target range?

When the FED changes its administrative rates, it affects the opportunity cost of holding reserves, prompting banks to adjust their reserve levels in response to new rates, ultimately leading to arbitrage opportunities that align the Fed Funds Rate (FFR) with the new targets.

How does monetary policy influence the economy?

Monetary policy influences the economy through mechanisms that affect interest rates, investment, consumer spending, and ultimately aggregate demand.

You should be able to graph and explain this transmission mechanism for both the limited and ample frameworks.

The transmission mechanisms vary: in ample reserves, changes in rates more directly affect bank lending and liquidity, while in limited reserves, impacts may be harder to trace through to the economy.

How can expansionary monetary policy be used to close a recessionary gap?

Expansionary monetary policy, through lowering interest rates, stimulates borrowing and spending to increase aggregate demand, helping to close a recessionary gap.

Is monetary policy useful for managing inflationary pressure?

Yes, monetary policy can be effective in managing inflation by controlling the money supply and influencing interest rates.

Are there reasons to prefer monetary policy to fiscal policy?

Monetary policy can be adjusted more quickly and is typically less politically influenced compared to fiscal policy.

What about fiscal over monetary?

Fiscal policy can directly target demand through government spending and taxation changes, which can be more effective during certain economic conditions.

Is it possible to target the money supply and the interest rate simultaneously?

No, targeting both simultaneously is generally considered impossible due to the inverse relationship between money supply and interest rates.

What is the Quantity Theory of Money? Does this mean that monetary policy is useless?

The Quantity Theory of Money posits that the money supply is directly proportional to the price level. It does not mean monetary policy is useless, as it can still influence economic activity even if its effectiveness varies.

How did we end up with ample reserves in the banking system?

Ample reserves in the banking system resulted from policies such as quantitative easing, where central banks increased the money supply to stimulate the economy after the financial crisis. This led banks to hold excess reserves beyond what was required.