monetary policy

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Monetary policy : 

Monetary policy Monetary policy is the process by which the government, central bank or monetary authority of a country controls (i) the supply of money (ii) availability of money (iii) cost of money or rate of interest in order to attain a set of objectives oriented towards the growth and stability of the economy

GOALS OF MONETARY POLICY : 

GOALS OF MONETARY POLICY To assist the economy in achieving a full-employment, non inflationary level of total output Monetary policy is geared towards influencing interest rates If government can affect interest rates, then the government can affect consumer and firm behavior

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expansionary policy expansionary policy increases the total supply of money in the economy used to combat unemployment in a recession by lowering interest rates, contractionary policy contractionary policy contractionary policy decreases the total money supply involves raising interest rates in order to combat inflation increasing interest rates slows the economy by making funds more expensive to firms, and promotes consumer savings which decreases revenues by firms.

TOOLS OF MONETARY POLICY : 

TOOLS OF MONETARY POLICY Open-Market Operations Buying Securities From commercial banks... Bank gives up securities FED pays bank Banks have increased reserves From the public... Public gives up securities Public deposits check in bank Banks have increased reserves Buying increases the money supply and lowers rates

Open-Market Operations : 

Open-Market Operations Selling Securities To commercial banks... FED gives up securities Bank pays for securities Banks have decreased reserves To the public... FED gives up securities Public pays by check from bank Banks have decreased reserves Selling decreases the money supply and increases rates

The Reserve Ratio : 

The Reserve Ratio Raising the Reserve Ratio Banks must hold more reserves Banks decrease lending Money supply decreases Lowering the Reserve Ratio Banks may hold less reserves Banks increase lending Money supply increases

The Discount Rate : 

The Discount Rate Easy Money Policy Buy Securities Decrease Reserve Ratio Lower Discount Rate Tight Money Policy Sell Securities Increase Reserve Ratio Raise Discount Rate

Cause-Effect Chain Interest Rates and Money Supply : 

Cause-Effect Chain Interest Rates and Money Supply Interest Rates and Money Supplying money supply affect interest rates 1. An increase in money supply makes the economy feel wealthier by putting more money in the hands of consumers 2. An increase in money supply decreases interest rates When interest rates are attractive to consumers and firms, they borrow & buy, hence increasing money supply increases economic activity

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Real domestic output, GDP Dm Investment Demand Real rate of interest, i 10 8 6 0 Quantity of money demanded and supplied Amount of investment, i MONETARY POLICY AND EQUILIBRIUM GDP Sm1 AS AD1(I=$15) P1 10 8 6 0 Sm2 AD3(I=$25) P2 If the Money Supply Increases to Stimulate the Economy… Interest Rate Decreases Investment Increases AD & GDP Increases with slight inflation Price level AD2(I=$20) P3 Sm3 Increasing money supply continues the growth – but, watch Price Level.

Impacts of tight money policy2007 : 

Impacts of tight money policy2007 Excess aggregate demand pressures in the economy reduced Hold in import demand was successful in sustaining a downtrend in inflationary pressures effective liquidity management has allowed adequate growth in private sector credit