ECON 311 1st EditionFinal Exam Study GuideChapter 13Monetary Policy ToolsOpen Market Operations (OMP and OMS)OMP: MS : MB ↑OMS: MS : MB ↓Reserve Requirementrr ↑  MB ↓Discount Rate ↑Discount rate  DL↓ MB↓Duties of Board of Governors Open market Operations (T-bills: traditional monetary policy tool) Set reserve requirement (% of checkable deposits)Control discount rate (Fed’s interest rate for lending)Review bank budgetsSupervise foreign banksDuties of Federal ReserveClear checksIssue new currencyMake discount loansEvaluate proposal of mergers/acquisitionsExamine state-chartered banks (bank holding companies)Collect data/research2 Types of Policy IndependenceThese 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.1) Instrument independence: the ability of the central bank to set monetary policy instruments 2) Goal independence: the ability of the central bank to set the goals of monetary policy4 Players in the Money Supply ProcessBanksDepositorsThe central bankBorrowers Simple Money Multiplier: (1/rr)Money Multiplier: m = (c+1) / (c +er + rr)MS = m x MBFactors that determine the money multiplierChange in reserve requirement, rr ↑m↓ MS ↓Change in currency ratio, CC↑  m↓ MS ↓Change in excess reserves, erer↑  m↓ MS ↓er is negatively related to i: i↑  er↓  m↑  MS↑er is positively related to deposit outflow: er↑  m↓ MS ↓Factors that affect MS (DIRECT IMPACT)c errrMBNB (Open market operations)MBB(discount loans)Factors that affect MS (INDIRECT IMPACT)Interest rateDeposit outflowShort answer PRACTICE questions 1. Explain the similarities and differences between the European System of Central Banks and the Federal Reserve System.a. The similarities between the two are in their structure. The National Central Banks of the member countries of the Eurosystem have the same role as the Federal Reserve Banks in the Federal Reserve System. The Executive Board and the Governing Council of the Eurosystem resemble the Board of Governors and the Federal Open Market Committee of the Federal Reserve System, respectively. There are three major differences between the two. The first difference is concerning the control of the budgets. In the Fed, the Board of Governors controls the budgets ofthe Reserve Banks while in the Eurosystem, the National Banks control the budget of the European Central Bank. The second difference is the monetary operations of the Eurosystem are conducted by the National Banks, so they are not as centralized as the monetary operations in the Federal Reserve System. Finally, the European Central Bank is not involved in the supervision and regulation of the financial institutions in the euro zone while the Federal Reserve is involved with the regulation and supervision of the financial institutions in the United States.2. Explain the differences between the federal funds rate and discount rate?a. The Fed funds rate is the interest rate at which depository institutions lend balance at the Fed Reserve to other depository institution overnight. b. The Discount rate is charged to commercial banks and other depository institutions on loans they receive from the regional Fed.3. What are the three tools of monetary policy and how each tool affect money supply?a. The Federal Reserve basically uses three tools to affect the supply of money available for the economy. Open-market operations are the most subtle of the three, and consist of the buying and selling of U.S. treasury securities to “gently” increase or decrease the money supply in small increments over time. The discount rate is the interest rate banks are charged when they borrow from the Federal Reserve. The discount rate can be altered by the Federal Reserve either to encourage or discourage borrowing from financial institutions. A changein the discount rate has a more pronounced effect on the money supply, and is often used to send a clear message to the financial community regarding the Federal Reserve’s intentions to increase or decrease the money supply. The U.S. practices what is known as “fractional reserve banking.” The reserve requirement is the percentage of some deposits that banks must keep as vault cash, or on account with the Federal Reserve at all times. If you deposit $100 intoyour checking account, your bank must hold a certain percentage of that deposit in reserve. The rest of your deposit may be used by the bank to make a loan for example. 4. If a person selling bonds to the Fed cashed the Fed's check, please show the transaction in the following T- accounts. Explain the effect on Monetary Base and reserves.Non bank publicAssets LiabilitiesS↑ C↑Fed Assets LiabilitiesS ↓C↑↑MB = ↑C + R5. Explain two ways by which the Federal Reserve System can increase the monetary base.a. The Fed can increase the monetary base by purchasing government bonds and by extending discount loans. If the person selling the security chooses to keep the proceedsin currency, bank reserves do not increase. Because the Fed cannot control the distribution of the monetary base between reserves and currency, it has less control over reserves than the base.6. If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, answer the following questions depending on the information above. a. The currency ratio 0.5i. er = (ER / D) = 0.8 / 800 = .001m = (1 + 0.5) / (0.5 + .001 + 0.1) = 2.5b. The excess reserve-checkable deposit ratio 0.001i. c = (C / D) = 400 / 800 = .5m = (1 + 0.5) / (0.5 + .001 + 0.1) = 2.5c. Monetary base 480.8Mi. MB = C + R = 480.8C = c x D = 0.5 x 800 = 400480.8= 400+ RR = 80.8d. Ml money multiplier 2.5i. m = (1 + 0.5) / (0.5 + .001 + 0.1) = 2.5e. If the Fed increases the required reserve ratio to 15%, then the Ml money multiplier is 2.3i. m = (1 + 0.5) / (0.5 + .001 + 0.15) = (1.5) / (.651) = 2.3 TRUE f. What is the money multiplier from the simple deposit expansion model?m = (1/reserve requirement ratio) =