AP Economics

Mr. Bernstein

Module 31: Money Policy and the Interest Rate

March 3, 2015

2

AP EconomicsMr. Bernstein

Monetary Policy and the Interest Rate• Objectives - Understand each of the following:• How the Federal Reserve implements monetary policy,

moving the interest rate to affect aggregate output• Why monetary policy is the main tool for stabilizing the

economy

3

AP EconomicsMr. Bernstein

Monetary Policy and the Interest Rate:Targeting the Fed Funds Rate

• How Do Fed Open Markets Operations increase M2?• (Buying or Selling? What instruments?)

• What is the effect of the operation on short-term interest rates in the Money Market?

4

AP EconomicsMr. Bernstein

Expansionary Monetary Policy• Fed buys securities• MS increases – money

is dropped into thesystem

• Rates decrease• How does this link

to Real GDP?

5

AP EconomicsMr. Bernstein

Expansionary Monetary Policy & the Economy• Lower i leads to

increase in Investment• AD increases

6

AP EconomicsMr. Bernstein

Contractionary Monetary Policy• Fed sells securities• MS decreases – pulls

excess reserves out ofsystem

• Rates increase• How does this link

to Real GDP?

7

AP EconomicsMr. Bernstein

Contractionary Monetary Policy & the Economy• Higher i leads to

decrease in Investment• AD decreases

8

AP EconomicsMr. Bernstein

Monetary Policy in Practice• The Fed is balancing multiple objectives which may

at times conflict• Price Stability• Full Employment