sell

If banks are able to borrow from the Federal Reserve at a low interest rate and
make loans at a higher rate, the banks will earn a profit and, hence, have an
incentive to use the discount window.

Borrowing from another financial institution will have fewer transaction

costs, plus the bank will not have the added scrutiny of its business
practices that borrowing from the Federal Reserve will generate.

one

If the Fed wants to increase the money supply, it will institute a policy to increase
reserves (giving banks an increased ability to make loans). Banks have more money
to loan to other banks, businesses and consumers, so the federal funds rate is likely
to decrease.
 Sell Treasury securities
Buy Treasury securities
Lower the discount rate Raise the discount rate
Lower the required reserve ratio Raise the required
reserve ratio

Banks are required by law to hold required reserves; they hold some excess reserves as a
precaution in case of sudden withdrawals or changes in economic conditions.
 Changes in the required reserve ratio cause radical or strong changes in the
monetary system. It is difficult for financial institutions to adjust to changes
in the required reserve ratio. In general, the Fed uses the tools of monetary
policy to adjust the economy in smaller increments.

The discount rate has no impact if banks do not borrow from the
Federal Reserve; banks do not have to borrow because if they need
funds, they can always go to the federal funds market. It signals to the
banks and others how the Fed would like the money supply to change.

The Fed uses changes in reserves to affect the federal funds rate. It targets the
federal funds rate because the Fed believes that this rate is closely tied to
economic activity.
 Monetary policy is policy adopted by the monetary authority of a nation to control
either the interest rate payable for very short-term borrowing or the money supply,

From 1998 to 2002, what was the dominant focus of monetary policy and why? From
1998 to 2001, the focus of monetary policy was to slow the growth of the economy to
prevent an increase in inflation

Explain why the money supply and short-term interest rates are inversely
related. Money supply is money supply, regardless of the interest rate

Monetary policy is policy adopted by the monetary authority of a

nation to control either the interest rate payable for very short-
term borrowing or the money supply,

Why do many economists believe that central banks have more control over
the price level than over real output ? Many economists believe that real
output is determined by the level of capital stock and the productivity of
workers .

Two of the most commonly cited factors that can cause changes in velocity are changes in
real interest rates and expectations ofinflation. Increases in the real interest rate tend
to cause individuals to hold less money relative totheir real income.
 I
f velocity were extremely volatile, why would this complicate the job of making
monetary policy? One of the roles of monetary policy is will yield a given change in
PQ if velocity (V) is constant.

Multiplier x Excess Reserves = Change in Money Supply. If the Fed wants to

change the money supply by a given amount, the money multiplier indicates by how
much the excess reserves need to be changed

n the United States, the federal funds rate is the interest rate at which depository
institutions lend reserve balances to other depository institutions overnight on an
uncollateralized basis

The interest rates at which banks lend to other banks for short term
borrowing. What happens to the fed funds rate if the Fed follows a
contractionary (tight money) policy.

The federal funds rate decreases.

Why do observers pay close attention to the federal funds rate? It is an early indicator of
monetary policy and provides a forecast of the direction for other interest rates and for Fed
policy.
The actual real interest rate has not been constant because the inflation rate has
changed often. The money supply growth rate has also changed during the period
shown in the graph.

During the 1995 to 2000 period, the actual real interest rate fluctuated
within a small range. The result is probably because of the reasonably
steady inflation rate and the announced desire by the Fed to control
inflation.

A steady interest rate is important to induce firms to invest and expand the
capital stock.

the Fed decides to implement expansionary monetary policy to increase the

level of employment.
Real output should increase. With the decrease in interest rates because of the
expansionary monetary policy, the interest rate sensitive components of aggregate
demand (consumption and investment) will increase, thereby increasing output.

The price level increases because the increase in demand can only be met if firms
have the incentive to produce more. An increasing price level provides this
incentive.

Employment increases and nominal wages remain the same. Employment increases
because firms now have to produce more goods and services and they need people
to do this. Nominal wages stay the same because people do not realize that the
average price level has increased.

In the short run, the nominal and real interest rates decrease

y. In the long run, the real output will be at the full-employment level. So real output
will fall relative to the level of output in the short run. As employment increases,
nominal wages increase, which raises the costs of production and the SRAS curve
shifts to the left. The price level increases, and real output will fall back toward its
original level.

The price level rises in the long run because the SRAS curve shifted to the left in
response to an increase in nominal wages.

mployment is at full employment and nominal wages have risen so that the real
income of people has remained the same. To induce labor to work at the new
higher level, firms must increase the nominal wage.

In the long run, the real interest rate goes to the long-run level and the
nominal interest rate is the real interest rate plus the inflation rate. In the
United States, the long-run real interest rate is about 2 percent to 3 percent.