Monetary Policy

Arshad Hayat
arshad.hayat@mup.cz
 MONETARY POLICY
• Monetary Policy: Central Bank’s policy to change the
money supply in order to achieve macroeconomic goals.

Goals?
Economic Growth and ultimately decrease unemployment
(growth targeting policy)
Control Inflation (Inflation targeting policy)
Tools of Monetary Policy

• Open-market operations (buying and selling treasury

bonds, notes, and bills).
• Discount rate: Interest rate banks are charged when
they borrow from the Central Bank.
• Reserve requirement: % of deposits that must be held
by a bank as vault cash or on account with the Central
Bank.
 Open Market Operations
Open Market Sale
• When the Central Bank sells bonds (treasury securities):
What happens to money Supply?

Open Market Purchase

• When the Central Bank buys bonds (treasury securities):
What happens to money Supply?
 Reserve Requirement
• Commercial Banks, Savings Banks, Savings and Loans, Credit
Unions, and Branches of Foreign Banks are subject to reserve
requirements.
 The Discount Rate
• The discount rate is adjusted to complement open market operations
and to support the direction the Fed is taking in monetary policy.
Types of Policy
Expansionary Monetary Policy:
Increase Money Supply---Decrease Interest Rate---Increase AD

Contractionary Monetary Policy

Decrease Money Supply---Increase Interest Rate---Decrease AD
 The Money Market and the Aggregate-Demand Curve

(a) The Money Market (b) The Aggregate-Demand Curve

Interest Money Price

Rate supply Level
2. . . . increases the
demand for money . . .

r2 P2
Money demand at
price level P2 , MD2
r 1. An P
3. . . .
which increase
Money demand at in the Aggregate
increases
price level P , MD price demand
the
equilibrium 0 level . . . 0
Quantity fixed Quantity Y2 Y Quantity
interest
by the CB of Money of Output
rate . . .
4. . . . which in turn reduces the quantity
of goods and services demanded.
 Expansionary Monetary Policy (Monetary Expansion )

(a) The Money Market (b) The Aggregate-Demand Curve

Interest Price
Rate Money MS2 Level
supply,
MS

r 1. When the Fed P

increases the
money supply . . .
2. . . . the r2
AD2
equilibrium
interest rate Money demand Aggregate
falls . . . at price level P demand, AD
0 Quantity 0 Y Y Quantity
of Money of Output
3. . . . which increases the quantity of goods
and services demanded at a given price level.
 Changes in the Money Supply
• The CB can shift the aggregate demand curve when it changes
monetary policy.
• An increase in the money supply shifts the money supply curve to
the right.
• Without a change in the money demand curve, the interest rate falls.
• Falling interest rates increase the quantity of goods and services
demanded. When the CB increases the money supply, it lowers the
interest rate and increases the quantity of goods and services
demanded at any given price level, shifting aggregate-demand to
the right.
• When the Fed contracts the money supply, it raises the interest rate
and reduces the quantity of goods and services demanded at any
given price level, shifting aggregate-demand to the left.