- Office Hourso Wednesday 2:30-4:30 in 7416 Social Scienceo Thursday 4-5 in 7416 Social Science and 5-6:30 in 6203 Social Science- HW # 5 due Wednesday- Conflict exam this Friday- look for email on Thursday--------------------------------------------------------------------------------------------------------------------- The Fed (continued)o The US is divided into federal districts (1913) Boston New York Philadelphia Richmond Atlanta Cleveland Chicago St. Louis Dallas Kansas City Minneapolis San Franciscoo 3 monetary policy tools The fed sets the RR ratio Sets the discount rate (the interest rate for banks that borrow money from the fed, which is a last resort to them)- This is generally higher than the interest rate at other banks to discourage borrowing from the fed *Conducts open market operationso Key points US treasury can’t print money to finance their deficit (this would cause inflation) The fed is not the same thing as the US treasury (otherwise there would be a tendency toward inflation)o Basic idea of open market operation Money market: Money supply is vertical because the fed controls the exact quantity of money ↑MS r↓ C↑ & I ↑ Y ↑ ↓MS r↑ C↓ & I ↓ Y ↓ Open market purchase e.g. :- RR ratio = 20% of DD (demand deposits)Money supply, MSInterest rateOpen mkt. purchase of treasury billsr1Money demand, MDOpen mkt. sale of treasury billsM1Q of money- Assume no currency drains (all transactions done by check; no coins/bills)- Assume no excess reserves (that the bank could loan out to make more money)- Assume no need to worry about net worth- Initial situation:- *T-accounts MUST balance- MS initially = DD = $100- Open market transaction: fed buys $10 in t-bills (to lower the interest rate)20% of DDBankFedLA LAReserves 20Earning assets & t-bills 80Reserves 20DD 100US gov’t. securities (t-bills) 2010010020 20BankFedLA LAReserves 20DD 100Reserves 20Earning assets & t-bills 80US gov’t. securities (t-bills) 20 3010010020 30 20- Required reserves = RR (DD’)30 = 0.2(DD’)DD’ = 150FedBankLA LAReserves 20 30DD 100Reserves 20Earning assets & t-bills 80US gov’t. securities (t-bills) 3010010030 20 30BankFedLA LAReserves 20 30Earning assets & t-bills 80 70Reserves 30DD 100US gov’t. securities (t-bills) 30Excess on reserve10010030 30BankFedLA LAReserves 30Earning assets & t-bills 70Reserves 30DD 100 150US gov’t. securities (t-bills) 30100 15010030 30- MS1 = 100MS2 = 150ΔMS = 50- * ΔMS = (money multiplier)*(Δ in reserves)ΔMS = (1/RR) *(Δ in reserves)ΔMS = (1/0.2) *(10)ΔMS = 50 Open market sale e.g. :- Initial situation:- The fed sells $20 in t-billsFed BankLA LAReserves 30Earning assets & t-bills 70 120Reserves 30DD 150US gov’t. securities (t-bills) 30100 15015030 30BankFedLA LAReserves 100Earning assets & t-bills 400Reserves 100DD 500US gov’t. securities (t-bills) 100500500100 100- Required reserve = RR(DD’)80 = (0.2)(DD’)DD’ = 400BankFedLA LAReserves 100 80Reserves 100Earning assets & t-bills 400DD 500US gov’t. securities (t-bills) 100 80500500100 80 100 80BankFedLA LAReserves 100 80Earning assets & t-bills 400 420Reserves 80DD 500US gov’t. securities (t-bills) 8050050080 80BankFedLA LAReserves 80Earning assets & t-bills 420 320Reserves 80DD 500 400US gov’t. securities (t-bills) 80500 400500 40080 80- ΔMS = (money multiplier)(Δ reserves)= 5(-20) = -100 Because the fed controls MS it also controls the interest rate ↑MS (open market purchase) ↓r ↑I ↑AE ↑Y… ↓MS (open market sale) ↑r ↓I ↓AE ↓Y… Liquidity trap: there is a point where monetary policy is no longer effective (r can only go so low- it can’t go below 0) Money market:- Final Model: Aggregate demand/aggregate supply (AD/AS)o Models: Fiscal policy (ΔG or ΔT) Monetary policy (Fed ΔMS) Inflation: aggregate price level (P) Output: real GDP (Y) EmploymentInterest rateMSMDr1M1Q of moneyo AD = function of: P (- relationship) movement along AD A (+) I (+) G (+) X – M (+) MS (+) MD (-) T(-)o AS = function of: P (+) Commodity prices (-) Nominal wages (-) Productivity (+)SRASPP1ADY1YShift in
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