Econ 102 1st Edition Lecture 19Outline of Last Lecture I. “In Plain English” Federal ReserveOutline of Current LectureI. Chapter 14Current LectureI. Chapter 14a. Principle of Opportunity costi. Rates vs Money Demand1. moves up and to the leftii. 3 reasons for Md1. Transactions Demanda. depends on GDP, P2. Liquidity Demanda. future transactionsb. ex: december graduates saving for january rent3. Speculative Demanda. changes in riskiii. Holding 1,2,3 constant Md increases if and only if r de-creasesb. Changes in bank behavior affect both interest rates and the money supplyThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.i. The money multiplier increases if the reserve ratio falls (banks make more loans, hold less in reserve)1. Money supply shifts right at any interest rate2. Money supply > Money demand at the initial interestrate. Money demand will only rise if the opportunity cost of holding money falls3. “If the banks are lending more, someone is borrow-ing more”a. only way is if the cost of the loan is LOWERb. price/ interest rate is lowerii. The money multiplier decreases if the reserve ratio rises (banks make fewer loans, hold more in reserve)1. Money supply shifts left and interest rates increase (loans are more scarce so they are also more expen-sive)2. cost is going to go up3. more expensive loans = higher interest ratesiii. open market operations 1. The purchase or sale by the Fed of short-term U.S. government securities on the secondary bond mar-ket.2. The federal reserve bank IS NOT directly buying bondsa. it is illegal for them to directly lend to the US governmentiv. open market purchases 1. The Fed’s purchase of short-term government2. bonds from the private sector on the secondary bond market3. the total amount of US government borrowing is un-affected by monetary policy4. they can do anything they want on SECONDARY mar-kets.v. open market sales 1. The Fed’s sale of short-term government bonds to theprivate sector on the secondary bond marketvi. federal funds market 1. The market in which banks borrow and lend reservesto and from one another. (Also known as the “inter-bank lending market”)2. overnight, or two days very short term3. inflation therefore doesn't mattervii.federal funds rate 1. The interest rate on reserves that banks lend each other. The federal funds rate is a very short term, risk-free and inflation-free interest rate.viii. Note: there is nothing “federal” about the federal funds market!1. It is a private market with private trades between banks. It was2. Highly regulated (hence “federal”) until 1980 and thename stuck. 3. Don’t set the market, just influencea. although because US has always hit the mark itfeels like they're setting itix. If the Fed wishes to increase the supply of money, it can reduce banks’ reserve requirements so they have more money to loan out.x. Open Market Operations are the primary Fed policy tool, but there are two other tools at their disposal that are fre-quently used in some other countries:1. discount rate a. The interest rate at which banks can borrow from the Fed.b. During a recession its a risky time, banks dont want to lend because they're afraid they wont be paid back. If they have more reserves (ex-cess reserves) they wont lend them. Therefore interest rates dont fall and Aggregate demand doesn't go upc. I’m not playing with the money because I’ll loseit!d. Reserves build up dramaticallyi. “pushing on a string” cant use the policy ii. you cant make the banks lendiii. CAN however, PULL aggregate demandiv. Asymmetric: works better to reduce ag-gregate demand then to increase
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