Monetary Policy Monetary Policy ToolsTools

(Federal Reserve Bank of NY)(Federal Reserve Bank of NY)

Instruments of monetary policy:Instruments of monetary policy:

• Open market operations:Open market operations: interest ratesinterest rates

monetary basemonetary base

• Reserve requirementsReserve requirements

• Discount window lendingDiscount window lending

1. 1. Open market operationsOpen market operations

The most direct and frequently used way of The most direct and frequently used way of changing the money supply is by raising or changing the money supply is by raising or lowering the monetary base through open-lowering the monetary base through open-market operationsmarket operations

Government securities Government securities Debt warrants Debt warrants (also called “(also called “IOUsIOUs” = “” = “I owe youI owe you”) ”)

Federal reserve wants to decrease Federal reserve wants to decrease monetary basemonetary base

Sellinggovernmentsecurities

FED debits commercial banks Banks

debit its clients’ accounts

Federal funds rate goes up

Interest rates rises

Slowing the economy and curbing inflationSlowing the economy and curbing inflation

The aim – to increase monetary baseThe aim – to increase monetary base

A boost in economyA boost in economy

Buyinggovernmentsecurities

FED credits commercial banks Banks

credit its clients’ accounts

Federal funds rate goes down

Interest rates also goes down

2. 2. Reserve requirementsReserve requirements (RR)(RR)

– – percentages of certain types of deposits percentages of certain types of deposits that banks must keep on hand in their own that banks must keep on hand in their own vaults or on deposit at a Federal Reserve vaults or on deposit at a Federal Reserve BankBank

• RR raised banks reduce lendingRR raised banks reduce lending

• RR lowered banks increase lendingRR lowered banks increase lending

3. 3. Discount window lendingDiscount window lending

– – lending reserves to banks so they can lending reserves to banks so they can meet depositors’ demands or reserve meet depositors’ demands or reserve requirementsrequirements

Interest rate Interest rate Discount rateDiscount rate

2 types of monetary policy2 types of monetary policy

1.1. The aim - to check inflation.The aim - to check inflation.

The FED The FED raises discount raises discount

raterate

Economic activityEconomic activityslowedslowed

2 types of monetary policy2 types of monetary policy

2. FED wants to pep economic growth2. FED wants to pep economic growth

Economic activityEconomic activitystimulatedstimulated

Discount rateDiscount ratelowerslowers

Thank you for your Thank you for your attention!attention!