Monetary Policy - AP Macroeconomics

M1 includes cash and checkable deposits; M2 includes M1 plus savings deposits. M2 is broader, including less liquid forms of money than M1.

Monetary aggregates like M1 and M2. These statistical measures track different components of money in circulation.

Central bank provides funds to financial institutions in crisis. Prevents financial system collapse by providing emergency liquidity when needed.

Government borrowing reduces private investment. Higher government spending raises interest rates, discouraging private investment.

They are inversely related. Rising rates decrease bond values; falling rates increase bond values.

To promote maximum employment and stable prices. Balances the goals of full employment with price stability simultaneously.

Communicating future monetary policy intentions to influence expectations. Shapes market expectations about future policy without immediate rate changes.

Central bank sets an explicit inflation rate as policy goal. Provides transparency and accountability by committing to specific inflation levels.

Assets and liabilities including securities and currency in circulation. Reflects the central bank's monetary policy operations and financial position.

Banks borrow more; money supply increases. Lower discount rates encourage borrowing, expanding credit availability.

To oversee open market operations and monetary policy. The key Fed committee that meets regularly to set interest rate policy.

$MV = PY$, where $M$ is money supply, $V$ is velocity, $P$ is price level, and $Y$ is output. Demonstrates how money supply and velocity determine price level and output.

The relationship between nominal interest rates, real interest rates, and inflation. Shows how expected inflation affects the gap between nominal and real rates.

When interest rates are low and savings rates are high, limiting monetary policy effectiveness. Occurs when monetary policy becomes ineffective near zero interest rates.

Guiding central banks in setting interest rates. Provides a formula for optimal interest rate based on economic conditions.

Reduces purchasing power. Higher prices mean each dollar buys fewer goods and services.

Money supply changes do not affect real variables in the long run. Only affects nominal variables like prices, not real output or employment.

To stimulate economic growth and reduce unemployment. Lowers interest rates to boost economic activity during recessions.

To reduce inflation and cool an overheating economy. Raises interest rates to slow down an overheated economy.

Decreases money supply by restricting loans. More reserves required means banks must reduce lending capacity.

Increases money supply by allowing more loans. Fewer reserves required means banks can make more loans to borrowers.

Minimum reserves banks must hold, set by the Fed. This regulatory tool controls how much banks can lend relative to deposits.

Buying and selling government securities. The Fed's primary tool for implementing monetary policy through bond transactions.

By selling government securities. Selling bonds removes money from banks, reducing available reserves.

By purchasing government securities. Buying bonds injects money into banks, increasing available reserves.

To control inflation and ensure economic stability. Central banks use this dual mandate to maintain price stability and full employment.

The Federal Reserve System. The Fed is the central bank that implements U.S. monetary policy decisions.

Federal funds rate. This interbank lending rate influences broader economic interest rates.

Banks borrow less; money supply decreases. Higher discount rates discourage borrowing, contracting credit availability.