Econ 0110 1st Edition Lecture 27Current LectureOPEN MARKET OPERATIONSThe purchase or sale of Treasury securities by the Fed in the open marketThis tool is used to increase or decrease the amount of reserves in the system.This influences the overall money supply and the level of interest rates.Policy decisions concerning open market operations are made by the Federal Open MarketCommittee. (FOMC)A Fed PURCHASE of securities increases the money supply.A Fed SALE of securities decreases the money supply.Changing the amount of reserves in the system has a multiplier effect on the overall moneysupply and influences the level of interest rates.EXPANSIONARY MONETARY POLICY:AN OPEN MARKET PURCHASEThe Fed buys government securities from commercial banks and the general public in the “openmarket”.The Fed buys the bonds with a check. The seller of the bond now has more money and themoney supply has increased.(The Fed has CREATED money!)When the check is deposited in a bank, the bank’s reserves increase.Some of these excess reserves will be loaned out, and the money multiplier process begins.The Fed now owns the government bonds, and the public has more money. The money supply has increased.These 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.By law, the Treasury cannot borrow directly from the Fed.Thus, the Fed is not permitted to buy bonds directly from the Treasury.This law prohibits the Fed from printing money to finance government spending.In many countries, the Central Bank prints money to finance government spending. Thispolicy can lead to hyperinflation.When the Fed conducts an open market operation, it usually makes a transaction with a largeinvestment bank.Open market purchases and sales are carried out through the New York Federal ReserveBank.Open market operations are by far the most frequently used tool of the Fed to conductmonetary policy.CONTRACTIONARY MONETARY POLICY:AN OPEN MARKET SALE BY THE FEDSuppose the FED wants to decrease the money supply.The Fed will SELL government securities to the public.The Fed is paid by check.This removes reserves (DEPOSITS) from the banking system.This causes a DECREASE in bank reserves.Decreased bank reserves lead to both fewer bank loans and higher interest rates.Both effects are CONTRACTIONARY.THE ROLE OF THE TREASURY DEPARTMENTThe Treasury Department collects taxes and pays the bills of the Federal government.If government spending exceeds tax revenue, the government has a DEFICIT.The Treasury needs to BORROW money to cover the deficit.The Treasury issues BONDS and borrows money from the public.(By law, the Treasury cannot borrow directly from the Fed.)WHEN THE PUBLIC LENDS MONEY TO THE TREASURY AND BUYS BONDS FROM THE TREASURY,THE MONEY SUPPLY DOES NOT CHANGE.The public lends money to the Treasury and receives bonds.The bonds represent a legal contract indicating that the Treasury promises to repay its debt plusinterest.Now, the public has less money and the Treasury has more money.When the Treasury pays its bills, different members of the public receive the money.Thus, the money changes hands, but the amount of money in the economy does not change.AN OPEN MARKET PURCHASE BY THE FED CAUSES THE MONEY SUPPLY TO INCREASESuppose the Fed wishes to increase the money supply.The Fed writes a check to some bond owner and buys government securities from the public.The sellers give up their securities and receive checks that are deposited in banks.The Fed has created money out of nothing!New bank reserves have been created.The money supply has been INCREASED.SOME OF THE NATIONAL DEBT IS HELD BY THE PUBLICSOME OF THE NATIONAL DEBT IS HELD BY THE FEDYear 2000:Total Federal debt: $5.8 TrillionHeld by Public $2.9 Trillion 53%Held by Fed $2.7 Trillion 47%Year 2013:Total Federal debt: $17.4 TrillionHeld by Public $10.2 Trillion 59%Held by Fed $7.2 Trillion 41%The Treasury pays interest to the public and to the FED.This is the cost of borrowing.The Fed uses some of its interest income to pay its expenses and returns the remainderto the Treasury.TO GET DATA ON THE NATIONAL DEBTThe 2014 Economic Report of the President has 26 data tables: See Table B-26http://www.gpo.gov/fdsys/browse/collection.action?collectionCode=ERP&browsePath=2014&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=0THE INTEREST ON THE NATIONAL DEBT IS NOT NECESSARLY A LOSS TO THE ECONOMYThe interest on the debt is paid out of our taxes.Thus, the National Debt represents a cost to all taxpayers.Some of the interest on the debt is paid to US citizens and US business firms who hold Treasurysecurities.(Some interest is paid to foreigners.)Thus, some of the interest on the debt is a TRANSFER PAYMENT from US taxpayers to USbondholders.This interest on the debt does not represent a net loss to the US economy.The interest on the debt that is paid to US citizens and businesses represents aredistribution of money from taxpayers to bond holders.THE INTEREST ON THE NATIONAL DEBT THAT IS PAID TO FOREIGNERS IS NOT NECESSARILY ALOSS TO THE ECONOMYThe interest on the debt that is paid to foreigners represents a redistribution of moneyfrom US taxpayers to foreigners.In return for this tax payment, US citizens get the benefits of the government projectthat was financed by the borrowing.The loans from foreigners enable US taxpayers to put off paying for the cost ofgovernment spending. Thus, US taxpayers have lower current taxes. This represents aBENEFIT OF THE NATIONAL DEBT.The COST associated with this is that INTEREST MUST BE PAID.CONFLICTS IN ECONOMIC POLICYTHE TRADE OFF BETWEEN UNEMPLOYMENT AND INFLATIONEXPANSIONARY MONETARY POLICYSuppose the Fed conducts an open market purchase.Bank reserves increase.Bank loans increase, and interest rates decrease.These effects promote increases in economic growth, total output, and employment.Similarly, all of these effects promote demand-pull inflation.CONTRACTIONARY MONETARY POLICYTo slow down inflation, the Fed would conduct an open market sale.Bank reserves decrease.Bank loans decrease, and interest rates increase.These effects tend to lower inflation rates.Similarly, all of these effects would reduce growth of output and