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Monetary Policy Wrap-up Monetary Policy Wrap-up

U. S. has a Fractional Reserve Banking System Use a T-account • Bob Deposits U. S. has a Fractional Reserve Banking System Use a T-account • Bob Deposits $10, 000 into bank #1 • Reserve requirement = 10. 0% • Calculate total increase in bank deposits? • Calculate total increase in money supply? Bank #1 Assets Required Reserves ------------------$1, 000 Excess Reserves $9, 000 Loans Total Money Multiplier = 1/ res. ratio => 1/. 10 = $10, 000 Demand Deposits ------------------$10, 000 10 Bank Deposits => $10, 000 x 10 = $100, 000 ↑bnk dep. MS => $9, 000 x 10 = $90, 000 ↑ MS Liabilities -------------- • $10, 000

3 Tools of Monetary Policy • Discount Rate • Reserve Requirement • Open Market 3 Tools of Monetary Policy • Discount Rate • Reserve Requirement • Open Market Operations – To ↑ MS => Fed buys government securities (bonds) with “new money” from banks/public Federal Reserve Gov’t bonds $$$ “New” Money Public Market & Banks

Money Market MS is fixed/controlled by the Fed Demand for money = desire to Money Market MS is fixed/controlled by the Fed Demand for money = desire to “hold” money (Similar to M 1) You “hold” money for: Transactions Demand Precautionary Demand Speculative Demand Note: MD rarely shifts => but if it does, the Fed can adjust policy to offset any shift

Expansionary Monetary Policy AS/AD Model Money Market LRAS 1 Price Level MS 1 MS Expansionary Monetary Policy AS/AD Model Money Market LRAS 1 Price Level MS 1 MS 2 Nominal Interest Rate SRAS 1 Affects AD i 1 ----- E 2 P 1 MD ----------- E 1 ---- i -------2 P 2 E 1 Y 1 E 2 AD 1 Y 2 Qty of $ Real GDP 1) ↓ Discount Rate (banks borrow more from Fed) 2) ↓ Reserve Requirement (banks must hold less reserves => more loans) 3) Open Market Operations: Buy Securities => ↑ MS => ↓ i-rate 4) End Result: nominal i-rate falls => I ↑ & C ↑ => AD ↑ & Px Level ↑

Monetary Policy Review Sheet Monetary Policy Review Sheet

Contractionary Monetary Policy AS/AD Model Money Market Nominal Interest Rate Affects AD i 1 Contractionary Monetary Policy AS/AD Model Money Market Nominal Interest Rate Affects AD i 1 -------Q 2 Q 1 E 1 ----------- P 2 E 2 P 1 ------- E 2 E 1 AD 2 MD Y 2 Qty of $ SRAS 1 -------- i 2 ----- LRAS 1 Price Level MS 2 MS 1 Y 1 Real GDP 1) ↑ Discount Rate 2) ↑Reserve Requirement (banks must hold more reserves => less loans) 3) Open Market Operations: Sell Securities => ↓MS => ↑ i-rate End Result: ↓ MS => ↑ nominal i-rate => borrowing $ is more expensive => I ↓& C ↓ => AD ↓ & Px Level Falls