Monetary Policy
Noah Martinez
8 min read
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Study Guide Overview
This study guide covers monetary policy, focusing on the Federal Reserve's (Fed) tools and their impact on the economy. It explains expansionary and contractionary policies, their effects on aggregate demand (AD), and how they address recessionary and inflationary gaps. The guide also details the Fed's tools: the discount rate, reserve ratio, open market operations, and federal funds rate. Finally, it provides exam tips, practice questions, and emphasizes connecting monetary policy actions to AD/AS model and money market graphs.
#AP Macroeconomics: Monetary Policy - The Night Before 🌃
Hey! Let's get you prepped for the exam. We're going to break down monetary policy, make it super clear, and get you feeling confident. Think of this as your cheat sheet to success!
#Monetary Policy: The Basics
Monetary policy is all about how the Federal Reserve (the Fed) manages the economy by controlling the money supply and interest rates. Their goal? To influence aggregate demand and steer the economy towards stability. It's like the Fed is the captain of the economic ship, adjusting the sails to navigate through different conditions.
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Expansionary Monetary Policy (Easy Money): ⬆️ Money Supply, ⬆️ Real GDP
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Contractionary Monetary Policy (Tight Money): ⬇️ Money Supply, ⬇️ Real GDP
Monetary policy is the Fed's tool to correct the economy. Expansionary policy is used during recessions, and contractionary policy is used during inflation.
# Tools of the Federal Reserve 🛠️
The Fed has several tools to play with, each affecting the money supply in different ways. Let's break them down:
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Discount Rate: The interest rate the Fed charges commercial banks for borrowing money directly from the Fed.
- ⬇️ Discount Rate = Banks borrow more = ⬆️ Money Supply
- ⬆️ Discount Rate = Banks borrow less = ⬇️ Money Supply
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Reserve Ratio (Reserve Requirement): The percentage of deposits banks must keep in reserve and cannot loan out.
- ⬆️ Reserve Ratio = Less money to lend = ⬇️ Money Supply
- ⬇️ Reserve Ratio = More money to lend = ⬆️ Money Supply
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Open Market Operations (OMO): The Fed's most frequently used tool, involving buying and selling treasury bonds.
- Fed Buys Bonds = ⬆️ Money Supply (Think: Fed Buys = Bigger money supply)
- Fed Sells Bonds = ⬇️ Money Supply (Think: Fed Sells = Smaller money supply)
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Federal Funds Rate: The interest rate banks charge each other for overnight loans.
- ⬆️ Federal Funds Rate = Banks borrow less = ⬇️ Money Supply
- ⬇️ Federal Funds Rate = Banks borrow more = ⬆️ Money Supply
DR. ROOF - A helpful acronym for remembering the tools of monetary policy:
- Discount Rate
- Reserve Ratio
- Open Market Operations
- Federal Funds Rate
Remember, the Fed uses these tools to either increase or decrease the money supply. Think about the impact of each action on bank lending and the overall money supply.
Practice Question
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