Monetary Policy

Expansionary Monetary Policy

Problem: Unemployment and recession.

Federal reserve buys bonds, lowers reserve ratio, lowers the discount rate, or reduces the interest rate on reserves.

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Excess reserves increase

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Federal funds rate falls

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Money supply rises

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Interest rate falls

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Investment spending increases

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Aggregate demand increases

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Real GDP rises

Restrictive Monetary Policy

Problem: Inflation

Federal Reserve sells bonds, increases the reserve ratio, raises the discount rate, or increases the interest rate on reserves

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Excess reserves decrease

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Federal funds rate rises

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Money supply falls

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Interest rate rises

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Investment spending decreases

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Aggregate demand decreases

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Inflation declines

Reserve ratio is the portion (expressed as a percent) of depositors’ balances banks must have on had as cash.

The discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve Banks discount window.

The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight.