Chapter 6: Monetary Policy
1. What is Monetary Policy?
● Monetary Policy is the process by which a country’s central bank manages the money
supply and interest rates to achieve macroeconomic goals.
In the U.S., monetary policy is controlled by the Federal Reserve (the Fed).
2. Goals of Monetary Policy
● Price stability (control inflation)
● Full employment
● Stable economic growth
● Stability in financial markets
3. The Federal Reserve System
● Central Bank of the U.S., created in 1913.
● Structure:
○ Board of Governors (7 members)
○ 12 Regional Federal Reserve Banks
○ Federal Open Market Committee (FOMC): Makes key monetary policy
decisions
, 4. Tools of Monetary Policy
1. Open Market Operations (OMO)
● Buying and selling government securities in the open market.
● Most commonly used tool.
✅ Buy bonds → Increases money supply → Lowers interest rates
❌ Sell bonds → Decreases money supply → Raises interest rates
2. Discount Rate
● The interest rate the Fed charges commercial banks for borrowing money.
✅ Lower discount rate → Encourages borrowing → Increases money supply
❌ Higher discount rate → Discourages borrowing → Decreases money supply
3. Reserve Requirements
● The percentage of deposits banks must keep in reserve and not loan out.
✅ Lower reserve requirement → More loans → Increases money supply
❌ Higher reserve requirement → Fewer loans → Decreases money supply
Rarely changed because of its powerful impact.
4. Interest on Reserves
● The Fed can pay interest on the reserves held by banks, encouraging them to hold more
or less money depending on rates.
5. Types of Monetary Policy
Expansionary Monetary Policy
● Goal: Fight recession, increase GDP and employment.
1. What is Monetary Policy?
● Monetary Policy is the process by which a country’s central bank manages the money
supply and interest rates to achieve macroeconomic goals.
In the U.S., monetary policy is controlled by the Federal Reserve (the Fed).
2. Goals of Monetary Policy
● Price stability (control inflation)
● Full employment
● Stable economic growth
● Stability in financial markets
3. The Federal Reserve System
● Central Bank of the U.S., created in 1913.
● Structure:
○ Board of Governors (7 members)
○ 12 Regional Federal Reserve Banks
○ Federal Open Market Committee (FOMC): Makes key monetary policy
decisions
, 4. Tools of Monetary Policy
1. Open Market Operations (OMO)
● Buying and selling government securities in the open market.
● Most commonly used tool.
✅ Buy bonds → Increases money supply → Lowers interest rates
❌ Sell bonds → Decreases money supply → Raises interest rates
2. Discount Rate
● The interest rate the Fed charges commercial banks for borrowing money.
✅ Lower discount rate → Encourages borrowing → Increases money supply
❌ Higher discount rate → Discourages borrowing → Decreases money supply
3. Reserve Requirements
● The percentage of deposits banks must keep in reserve and not loan out.
✅ Lower reserve requirement → More loans → Increases money supply
❌ Higher reserve requirement → Fewer loans → Decreases money supply
Rarely changed because of its powerful impact.
4. Interest on Reserves
● The Fed can pay interest on the reserves held by banks, encouraging them to hold more
or less money depending on rates.
5. Types of Monetary Policy
Expansionary Monetary Policy
● Goal: Fight recession, increase GDP and employment.
