ECON 102 Lecture Notes - Lecture 15: Open Market Operation, Money Multiplier, Reserve Requirement
Econ 101
Principles of Microeconomics
Fall 2019
● How the FED can influence monetary control
○ It can influence the quantity of reserves
■ Open Market Operations
● DEF: open market operations – the purchase and sale of U.S
government bonds by the FED
● To increase the supply of money, the FED creates dollars and uses
them to purchase government bonds from the public in the nation’s
bond market
● To decrease the supply of money, the FED sells government bonds
from its portfolio to the public. Money is then taken out of the
hands of the public and the supply of money falls.
● If the sale or purchase of government bonds affects the amount of
deposits in the banking system, the effect will be made larger by
the money multiplier
● Open market operations are easy for the FED to conduct and
therefore, is the tool of monetary policy that the FED uses most
often
■ Federal lending to banks
● The FED can also lend reserves to banks
● DEF: discount rate – the interest rate on the loans that the FED
makes to banks
● A higher discount rate discourages banks from borrowing from the
FED and likely encourages banks to hold out larger amounts of
reserves (deposits), in turn lowering the money supply
● A lower discount rate encourages banks to lend their reserves (and
borrow from the FED). This will increase the money supply.
○ How the Federal Reserve influences the reserve ratio
■ Reserve Requirements
● DEF: reserve requirements – regulations on the minimum amount
of reserves that banks must hold against deposits
● This can affect the size of the money supply through changes in the
money multiplier
● The Federal Reserve rarely uses this tool because of the disruption
in the banking industry that would be caused by frequent alteration
of reserve requirements. It is also not effective when banks hold a
lot of reserves.
○ Problems in controlling the money supply
■ The Federal Reserve does not control the amount of money that
consumers choose to deposit in banks
Document Summary
How the fed can influence monetary control. It can influence the quantity of reserves. Def: open market operations the purchase and sale of u. s government bonds by the fed. To increase the supply of money, the fed creates dollars and uses them to purchase government bonds from the public in the nation"s bond market. To decrease the supply of money, the fed sells government bonds from its portfolio to the public. Money is then taken out of the hands of the public and the supply of money falls. If the sale or purchase of government bonds affects the amount of deposits in the banking system, the effect will be made larger by the money multiplier. Open market operations are easy for the fed to conduct and therefore, is the tool of monetary policy that the fed uses most often. The fed can also lend reserves to banks.
