Unit 4; Day 4 Notes

Three Tools of Monetary Policy
Reserve requirement-

• Only small % of bank deposit is safe. Rest is loaned out. “Fractional Reserve Banking”
• FED sets amount that banks must hold
• The reserve ratio is % of the deposits banks must hold
• When FED increases money supply, it increases money held in bank deposits 

If there is a recession, what should FED do to the reserve requirement?
Decrease reserve ratio
   Banks hold less $, more ER
   Banks create money by loaning out ER
   Money supply increases, interest fall, AD ^
If there is inflation, what should FED do to RR?
Increase RR
   Banks hold $, less ER
   Banks create less money
   MS decreases, Interest up, AD down

The Discount Rate-
   Interest rate that the FED charges commercial banks

Ex. If bank needs 10 mil, the borrow from US treasury(FED controls) but they must pay back with interest
To increase MS, FED decreases Discount rate(Easy money policy)
To Decrease MS, FED increases discount rate(Tight money policy)

Open Market Operations(OMO)-
   FED buys/sells govt bonds(securities)
Most important and widely used monetary policy
To increase MS, FED buys Govt securities
To decrease MS, FED sells govt securities


Federal Funds Rate-
   FDIC member banks loan each other overnight funds instead of FED.
Prime Rate-
Interest rates banks give to their most creditworthy customers