Tools of Monetary Policy

 Open – Market Operations

 Discount Rate
 Reserve Requirements
 How Open-Market Operations Work
- The Federal Reserve purchases a security

bonds to increase money supply and to

reduce the money supply the FED sells the
bonds.
The Federal Open-Market Committee
 Open – market operations are conducted by the
Federal Open – Market Committee.
 The Federal Open – Market Committee is the
group within the Federal reserve that creates
monetary policy.
 The Federal Open - Market Committee consist
of 12 people.
 Discount Rate and Federal Funds Rate
Changes
 Discount rate
- interest rate paid by member banks when they
borrow at the Federal reserve district bank.

 Federal Funds Rate

-Is the interest rate that depository institutions
,banks, savings and loans, and credit unions,
charge each other for overnight loans.
 Changing Reserve Requirements
 Increasing reserve requirements, the Federal
Reserve is essentially taking money out of the
money supply and increasing the cost credit.
 Lowering the reserve requirements pumps
money into the economy by giving bank excess
reserve, which expands the bank credit and
lowers rate.
 The Fed’s effectiveness in fighting
Inflation and Recession
 When the Fed increase the rate of monetary
growth, this tends to raise GDP growth.

 The monetary policy is having some difficulty

in handling recession, because business
Transmission Mechanism: Expansionary
Monetary Policy
Transmision Mechanism: Contractionary
 The Liquidity Trap
 Liquidity Trap
- when monetary policy becomes ineffective
due to a very low interest rates combined
with consumers who prefer to save raher
than invest in higher – yielding bonds or other
investments.

 John Maynard Keynes determined that at a very

low interest rates people would not lend out their
money.
 The Depository Institutions Deregulation
and Monetary Control Act of 1980
 Key Provisions
1. All depository instituions are now subject to
the Fed’s legal reserve requirements
2. All depository institutions are now authorized
to issue checking deposits.
3. All depository institutions now enjoy all the
advantages that only Federal Reserve member
banks formerly enjoyed.
 The Banking act of 1999
 The Gram – Leach – Bliley Act
- partially deregulates the financial industry.
- The law repealed big parts of the Glass –
Steagall Act of 1933.
Monetary Policy Lags
Fiscal and Monetary Policy Should Mesh
 Who controls our Interest Rates?
 The financial dependency of the U.S. Treasury
will have the foreign countries controlled the
Interest Rates. This foreign countries include,
Shanghai, Tokyo, London, Frankfurt and other
financial capitals.
 Current Issue: The Housing Bubble, the
Subprime Mortgage Mess, and the Financial
Crisis of 2008