CHAPTER
12
THE
FEDERAL RESERVE
MONETARY
POLICY
GENERAL INFORMATION
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THE FED WAS CREATED IN 1913 TO AID IN RESTORING
CONFIDENCE IN THE BANKING SYSTEM
STRUCTURE OF THE FED
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THERE ARE 12 FEDERAL RESERVE DISTRICTS
o
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THE BOARD OF GOVERNORS ARE APPOINTED BY THE
PRESIDENT FOR 14 YEAR TERMS
o
THIS CREATES
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BEN BARNAKE IS THE CURRENT CHAIRMAN
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SOMETIMES REFERRED AS AN ECONOMIC CZAR
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2ND MOST POWERFUL POSITION IN THE
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THE FOMC ( FEDERAL OPEN MARKET COMMITTEE) MAKES
DECISIONS AFFECTING THE GROWTH OF THE MONEY SUPPLY
o
BUYING AND SELLING BONDS
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THE FED IS OWNED BY THE MEMBER BANKS WHO ARE
REQUIRED TO MAINTAIN RESERVES WITH THE FED
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ENABLES THE FED TO EXERT MONETARY CONTROL
GENERAL DUTIES OF THE FED
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MAINTAIN OUR MONETARY SYSTEM
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KEEP OUR MONEY SOUND
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STABLE, RELIABLE AND VALUABLE
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IT ATTEMPTS TO CONTROL THE VOLUME OF MONEY (CREDIT)
IN CIRCULATION
SPECIFIC DUTIES OF THE FED
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SUPERVISE
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MEMBER BANKS
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BANK HOLDING COMPANIES
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INTL. BANKS THAT DO BUSINESS IN THE
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CLEARING HOUSE FOR CHECKS
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ENFORCES CONSUMER LEGISLATION
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TRUTH IN LENDING ACT – REGULATION “Z”
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SIZE OF DOWN PAYMENT
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THE NUMBER AND SIZE OF MONTHLY PAYMENTS
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TOTAL AMOUNT
OF INTEREST TO BE PAID
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THE A.P.R. (ANNUAL PERCENTAGE RATE)
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PRINT AND COIN MONEY
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SET MARGIN REQUIREMENT (SEC)
o
THE % OF DOWN PAYMENT NEEDED TO BUY STOCK
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INTENDED TO STOP SPECULATION
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USUALLY SET AROUND 50 – IT COULD BE SET AT 100
MONETARY POLICY
Monetary Policy.htm
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INTENDED TO
o
CONTROL THE EXPANSION AND/OR CONTRACTION OF THE
MONEY SUPPLY
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INFLUENCE THE COST AND THE AVAILABILITY OF MONEY
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THEREBY INFLUENCING ECONOMIC ACTIVITY
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CONTROLS THE VOLUME OF MONEY IN CIRCULATION
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IN THE U.S. BANKS OPERATE UNDER THE FRACTIONAL RESERVE SYSTEM
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THEY ARE ONLY REQUIRED TO MAINTAIN A SMALL AMOUNT OF
MONEY ON HAND WHILE BEING ABLE TO LEND THE REMAINING AMOUNT OF DEPOSITS
§
THE MORE MONEY THAT A BANK CAN LEND OUT, THE MORE
INCOME IT CAN MAKE
o
THE FRACTIONAL RESERVE SYSTEM ALLOWS THE MONEY
SUPPLY TO GROW SEVERAL TIMES THE AMOUNT OF MONEY HELD IN DEPOSITS
o
MONEY SUPPLY
= TOTAL RESERVES /
RESERVE REQUIREMENT
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EXAMPLE
$5000 = $1000 / .20
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THE MONEY SUPPLY IN THEORY CAN EXPAND 5 TIMES WITH A
RESERVE REQUIREMENT OF 20%
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TOOLS OF MONETARY POLICY
§ RESERVE REQUIREMENT (INCLUDES VAULT CASH PLUS DEPOSITS WITH THE FED)
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Def – AN AMOUNT OF MONEY THAT A BANK IS PROHIBITED
FROM LENDING
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THIS SPECIFIC MONETARY POLICY COULD POTENTIALLY HAVE
THE GREATEST IMPACT UPON THE MONEY SUPPLY
o
RESERVES ACT AS A RESTRAINT ON THE POWER OF BANKS TO
MAKE LOANS AND EXPAND THE MONEY SUPPLY
§ REDISCOUNT RATE
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Def – THE INTEREST RATE CHARGED BY THE FED TO MEMBER
BANKS
o
THE REDISCOUNT RATE IN TURN AFFECTS SUCH RATES AS
THE PRIME RATE
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Def – THE INTEREST RATE CHARGED TO A BANK’S BEST
CUSTOMERS
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THIS WILL AFFECT THE WILLINGNESS OF THOSE WHO MIGHT
WANT TO BORROW MONEY
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A BANK’S MARGINAL PROFIT (SPREAD) IS
USUALLY
2%
OR 3 %
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OPEN MARKET OPERATIONS
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THE BUYING AND SELLING OF GOVERNMENT BONDS BY THE
F.O.M.C.
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THE QUICKEST WAY TO AFFECT THE MONEY SUPPLY
§ MORAL SUASION
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THE USE OF PUBLIC PRONOUNCEMENTS TO INFLUENCE THE
PUBLIC
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SOMEWHAT A “TRIAL BALLOON”
UTILIZATION OF MONETARY
POLICY
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COMBATING INFLATION
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RAISE RESERVE REQUIREMENT
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RAISE REDISCOUNT RATE
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SELL BONDS
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COMBATING DEFLATION
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LOWER RESERVE REQUIREMENT
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LOWER REDISCOUNT RATE
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BUY BACK BONDS
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IT IS MUCH EASIER FOR THE FED TO COMBAT INFLATION
THAN DEFLATION
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CURING DEFLATION IS LIKE “PUSHING A STRING
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IN THE SHORT RUN, MONETARY POLICY AFFECTS INTEREST RATES AND THE AVAILABILITY
OF CREDIT BUT IN THE LONG RUN, IT AFFECTS INFLATION AND DEFLATION
THE QUANTITY THEORY OF MONEY
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THE SUPPLY OF MONEY DIRECTLY AFFECTS THE PRICE LEVEL
IN THE LONG RUN
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SHORT TERM EFFECT OF MONETARY POLICY
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AN INCREASE IN THE SUPPLY OF MONEY WILL EXERT
DOWNWARD PRESSURE ON INTEREST RATES
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A DECREASE IN THE MONEY SUPPLY WILL EXERT UPWARD
PRESSURE ON INTEREST RATES
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LONG TERM EFFECT OF MONETARY POLICY
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THE EFFECT WILL BE ON PRICES - I.E. – INFLATION OR DEFLATION
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MONETIZING THE DEBT
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AN ATTEMPT BY THE FED TO OFFSET THE UPWARD PRESSURE
ON INTEREST RATES CAUSED BY DEFICITS
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IT AMOUNTS TO PRINTING MORE MONEY
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DANGER OF HYPERINFLATION
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TIMING AND BURDEN ARE TWO IMPORTANT CONSIDERATIONS
THAT THE FED TAKES INTO ACCOUNT WHEN ESTABLISHING MONETARY POLICY
o
AN INCREASE IN INTEREST RATES MIGHT UNINTENTIONALLY
BURDEN THE HOME CONSTRUCTION AND AUTO INDUSTRIES
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THE IMPACT OF MONETARY POLICY IS TIME UNPREDICTABLE
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IT IS VARY DIFFICULT TO FINE TUNE MONETARY POLICY
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THE FED IS FOLLOWING A “TIGHT MONEY” WHEN IT
RESTRICTS THE MONEY SUPPLY BY RAISING INTEREST RATES
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THE FED IS FOLLOWING A “LOOSE MONEY” POLICY
WHEN IT ENCOURAGES AN INCREASE IN CREDIT IN ORDER TO ENCOURAGE BUSINESS
EXPANSION
FISCAL POLICY
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POLICY OF GOVERNMENT WHICH ATTEMPTS TO AFFECT THE VELOCITY OF MONEY
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THE SPEED AT WHICH MONEY IS EARNED AND SPENT
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EXAMPLES
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TAX POLICY
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DEFICIT SPENDING – PUMP PRIMING
§
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IN MOST INSTANCES, MONETARY POLICY WILL BE INITIALLY
ATTEMPTED BECAUSE IT IS EASIER TO IMPLEMENT THAN FISCAL POLICY
DEFINING MONEY (refer to
chart on p 315 in text)
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MONEY INCOME IS A FLOW WHEREAS
MONEY IS A STOCK
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M 1 - (TRANSACTIONAL
MONEY) MONEY USED AS A MEDIUM OF EXCHANGE
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JINGLING
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FOLDING
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CHECKBOOK
§
EXPANSIVE AND CONTRACTIVE PART OF THE MONEY SUPPLY
(MONEY STOCK)
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INCREASES OR DECREASES AS COMMERCIAL BANKS EXPAND OR
CONTRACT LENDING
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TRAVELERS CHECKS
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N.O.W. ACCOUNTS AND CREDIT UNION DRAFTS
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GENERALLY SPEAKING, M 2 =
M1 +
NEAR MONEY
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SAVINGS DEPOSITS
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SMALL DENOMINATION TIME DEPOSITS
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MONEY MARKET FUNDS
POLICY LAGS
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Def – PROBLEMS ASSOCIATED WITH TIMING OF MACROECONOMIC
POLICY
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INSIDE LAGS – DELAYS IN IMPLEMENTING POLICY
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IT TAKES TIME TO IDENTIFY AND RECOGNIZE A PROBLEM
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ONCE THE PROBLEM IS IDENTIFIED, IT TAKES TIME TO
ENACT APPROPRIATE POLICY
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THE PROBLEM IS MORE SEVERE WITH FISCAL POLICY
BECAUSE BOTH CONGRESS AND THE PRESIDENT MUST AGREE WHEREAS THE F.O.M.C. CAN ACT
RATHER QUICKLY BECAUSE IT MEETS REGULARLY (8X/YEAR)
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OUTSIDE LAGS
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TIME IT TAKES FOR POLICY TO BECOME EFFECTIVE
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SHORT PERIOD OF TIME FOR FISCAL POLICY AND A LONG
PERIOD OF TIME FOR MONETARY POLICY
WHY
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MONETARY POLICY AFFECTS BUSINESS INVESTMENT WHICH
CAN NOT BE READILY ACCOMPLISHED
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IT TAKES TIME TO BUILD NEW FACTORIES
ADDITIONAL INFORMATION
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THE DEMAND FOR MONEY DEPENDS UPON ITS EXPECTED VALUE
o
PEOPLE WILL SPEND MONEY IF THEY EXPECT ITS VALUE TO
FALL
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PREFERRED MONEY BALANCES
o
THE AMOUNT OF MONEY AN INDIVIDUAL IS WILLING TO HOLD
AS STOCK (NOT SPENT)
o
MORE MONEY PRODUCES MORE SPENDING