Monetary Goals and Tools:
Fed has several tools by which it influences the amount of money in the economy and the general level of interest rates. The tools are reserve requirements, open market operations, open market repurchase agreements, and the discount rate. These are the ways that Fed interacts with commercial banks in the process of creating money. Reserve requirements –US has fractional reserve banking system-to maintain specified fractional amts of reserves against their deposits. Feds can raise/lower required reserve ratios allowing banks to decrease/increase their lending and investment portfolios. Open market operations – fed’s most powerful instrument – Fed may buy and sell in open debt markets, govt securities for its own account. Open market repurchase agreements – Fed employs variants of simple open mkt purch and sales. Fed uses repos and reverse repos to bring about a temp change in level of reserves in system. Discount Rates – Fed makes loans to banks that are members of the system. Banks borrowing from Fed use the discount window and these loans are backed by the bank’s collateral. The rate of interest on these loans is the discount rate Goals = Fed manages money supply in order to achieve certain economic goals. Price Stability-like inflation can slow economic growth, foster unpredictable interest rates, and deter savings. Sometimes stagflation could occur-when prices are high even though there is already high unemployment. Policy makers prefer price acceleration. High Employment-full employment is goal but unemployment can’t be 0 because of frictional unemployment-temp unemploy. Due to transitions. Increase in money supply can help economic expansion and create more jobs, too much could also lead to inflation and increased interest rates. Economic Growth-aim is real growth of output of goods & services. volatile interest rates can be bad to fina. Institution soundness and econ growth, but Fed can help moderate cycles. Stability in foreign...
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