MONETARY POLICY

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Members :

Members Amna Noreen Mehroz Zaigham Momna Sarwar Sultan Waseem

Monetary Policy:

Monetary Policy The process by which the government, central bank or the monetary authority controls the Supply of money Availability of money Cost of money or rate of interest

Objectives of Monetary Policy:

Objectives of Monetary P olicy Achieve full-employment level Achieve non-inflationary level of output Monetary policy is geared towards influencing interest rates If government can affect interest rates, then the government can affect consumer and firm behavior

Tools of Monetary Policy:

Tools of Monetary P olicy Open Market Operations (OMO) Reserve Ratio (RR) Discount Rate (DR)

Open Market Operations (OMO):

Open Market Operations (OMO) Buying security: From commercial banks Bank gives up securities FED pays bank Banks have increased reserves From public Bank gives up securities FED pays bank Banks have increased reserves

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Selling Security To commercial banks FED gives up securities Bank pays for securities Banks have decreased reserves To Public FED gives up securities Public pays by check from bank Banks have decreased reserves

Reserve Ratio (RR):

Reserve Ratio (RR) 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

Discount Rate (DR):

Discount Rate (DR) Buy Securities Decrease Reserve Ratio Lower Discount Rate M oney Supply Increase Sell Securities Increase Reserve Ratio Raise Discount Rate Money Supply Decrease

Types of Monetary Policy:

Types of M onetary P olicy Expansionary monetary policy: Expansionary policy increases the total supply of money in the economy Contractionary monetary policy: Contractionary policy decreases the total money supply in the economy

Expansionary Monetary Policy:

Expansionary Monetary P olicy Problem: Unemployment &Recession FED buys bonds, lowers RR or lowers DR Excess Reserves increase Federal Fund Rate Falls Money Supply rises Interest Rate falls Investment spending increases Aggregate Demand increases RGDP rises

Contractionary Monetary Policy:

Contractionary Monetary P olicy Problem: Unemployment &Recession FED buys bonds, lowers RR or lowers DR Excess Reserves increase Federal Fund Rate Falls Money Supply rises Interest Rate falls Investment spending increases Aggregate Demand increases RGDP rises

Monetary Policy and Equilibrium GDP:

Monetary Policy and Equilibrium GDP (a). Quantity of money demanded and supplied Dm MS1 MS2 MS3 10 8 6 125 150 175 Rate of Interest ( i ) 10 8 6 (b). Investment demanded (I) 15 20 25 Rate of Interest ( i )

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(c). Real domestic output, GDP AS AD 1 (I=$15) P 1 AD 3 (I=$25) P 2 Price level AD 2 (I=$20) P 3

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