The Tools of Monetary Policy and Shifters of MS- 04/03/17

The Tools of Monetary Policy and Shifters of MS- 04/03/17

Tools of Monetary Policy:
1) Reserve Requirements
2) Open Market Operation
3) Discount Rate

Reserve Requirement:

-amount that must be kept in vaults
-FED sets the percent banks must hold

1) If there is a recession, what should FED do to the RRR?
Decrease the reserve ratio
-Banks hold less money and have more excess reserves
-Banks create more money by loaning out excess reserves
-MS increases, i decreases, AD increases

2) If there is an inflation, what should the FED do to the RRR?
Increase the reserve ratio
-Banks hold more money and have less ER

-Banks create less money
-MS decreases, i increases, AD decreases

Open Market Operation:
-FED buys/sells bonds
-most important and widely used monetary tool
-If fed buys bonds, MS increases
-If FED sells bonds, MS decreases

Discount Rates
-interest rate that FED charges Commercial banks for short term loans

Federal Fund Rate:
-interest rate that banks charge one another of overnight loans

Prime Rate:
-interest rate banks charge their most credit worthy customers