1) Reserve Requirement: Only a small percent of your bank deposit is in the safe, the rest of your money has been loaned out. This is "Fractional Reserve Banking". The FED sets the amount that banks must hold.
- When the FED increases the money supply it increases the amount of money held in bank deposits.
Example: If Bank of America needs $10 million, they borrow it from the U.S. Treasury (which the FED controls), but they must pay it back with interest.
- To INCREASE money supply, the FED should DECREASE the discount rate (expansionary)
- To DECREASE money supply, the FED should INCREASE the discount rate (contractionary)
- To INCREASE money supply, the FED should BUY securities.
- To DECREASE money supply, the FED should SELL securities.
Federal Fund Rate: where FDIC member banks make overnight loans to other banks
Prime Rate: interest rate that banks charge to their most credit worthy customers
Nice one! I too learned the same thing from notes, I learned that when to increase money supply, the FEDs should buy securities, and vice versa. Also, learning the three tools of monetary policy really helped me understand contractionary and expansionary too!
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