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Adapted from James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts
University 2005 Thomson Business & Professional Publishing, A Division of Thomson
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Learning
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Monetary Policy - Policy that involves
changing the rate of growth of the
money supply in circulation in order to
affect the cost and availability of
credit.
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THE FEDERAL RESERVE
SYSTEM: DEFINITIONS
Federal Reserve System: the central
bank of the United States
Board of Governors: the governing
body of the Fed
Federal Open Market Committee
(FOMC): the 12 member policymaking
group within the Fed. It has the
authority to conduct open market
operations
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THE FEDERAL RESERVE
SYSTEM: DEFINITIONS
Open Market Operations: the
buying and selling of government
securities (bonds) by the Fed
Monetary Policy: changes in the
money supply, or in the rate of
change of the money supply, to
achieve particular macroeconomic
goals
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FEDERAL RESERVE DISTRICTS AND
FEDERAL RESERVE
BANK LOCATIONS
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STRUCTURE OF THE
FEDERAL RESERVE
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THE CHECK-CLEARING
PROCESS
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FED TOOLS FOR CONTROLLING
THE MONEY SUPPLY: OPEN
MARKET OPERATIONS
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OPEN MARKET
OPERATIONS
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THE REQUIRED-RESERVE
RATIO
The Fed can also influence the money
supply by changing the required-reserve
ratio.
An increase in the required-reserve ratio
leads to a decrease in the money supply
A decrease in the required-reserve ratio
leads to an increase in the money
supply.
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THE DISCOUNT RATE
A bank can borrow from the federal funds
market or from the Fed.
Federal Funds Rate: The interest rate a
bank pays for a loan in the federal funds
market.
Discount Rate: The interest rate a bank
pays for a loan from the Fed.
When a bank borrows money from the Fed,
the money supply increases because its
reserves increase while the reserves of no
other bank decrease.
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THE SPREAD BETWEEN THE
DISCOUNT RATE AND THE
FEDERAL FUNDS RATE
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DISCOUNT RATE VS.
FEDERAL FUNDS RATE
If the discount rate is
significantly lower
than the federal funds
rate, most banks will
borrow from the Fed.
An increase in the
discount rate relative
to the federal funds
rate reduces bank
borrowings from the
Fed.
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WHICH TOOL DOES THE
FED PREFER TO USE?
Tools which can be used to influence the
money supply:
open market operations
the required-reserve ratio
the discount rate
The Fed prefers Open Market Operations
Open market operations are flexible
Open market operations can be reversed
Open market operations can be implemented
quickly
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FED MONETARY TOOLS & THEIR
EFFECTS ON THE MONEY
SUPPLY
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