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United States (325,778)
Economics (157)
ECON 0110 (84)

Section 32 Notes.doc

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ECON 0110

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SECTION 32: MAJOR POLICY TOOLS OF THE FEDERAL RESERVE SYSTEM THE REQUIRED RESERVE RATIO THE DISCOUNT RATE CONDUCT OPEN MARKET OPERATIONS TOOLS OF THE FED TOOL 1: REQUIRED RESERVE RATIO The percentage of deposits that a bank must keep as reserves Deposits required reserve ratio $0 - $54 million 3% Over $54 million 10% The Fed can raise or lower the required reserve ratio. This affects the amount of money that banks are able to lend to the public. EXPANSIONARY MONETARY POLICY: LOWER THE REQUIRED RESERVE RATIO This will free up excess reserves that can then be loaned out. This will increase the money supply. CONTRACTIONARY MONETARY POLICY: INCREASE THE REQUIRED RESERVE RATIO This will cause more required reserves to be held Less money will be available to be loaned out. This will decrease the money supply. Changing the required reserve ratio is used very rarely. TOOLS OF THE FED: TOOL 2: THE DISCOUNT RATE The interest rate that banks pay to the Fed when banks need to borrow from the Fed Assume a bank has loaned out too much money, or depositors suddenly withdrew money. Suddenly, the bank has less than the required amount of reserves. To get the REQUIRED amount of reserves, the bank can ask the Fed for an overnight loan. The Fed charges INTEREST on these loans. This is the PENALTY for violating the required reserve ratio. The rate is called the DISCOUNT RATE. The Fed can raise the discount rate (or INCREASE THE PENALTY) to discourage loans. The Fed can lower the discount rate (or DECREASE THE PENALTY) to encourage loans. EXPANSIONARY MONETARY POLICY: LOWER THE DISCOUNT RATE A decrease in the discount rate makes it cheaper for banks to borrow from the Fed and encourages banks to borrow from the Fed. In a sense, the discount rate is the penalty that banks pay for violating
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