The FOMC and Monetary Policy Tools: AP Macroeconomics Study Guide

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Institutional Facts Worth Memorising

Multiple-choice questions reward a small set of concrete facts. The Federal Reserve is the central bank of the United States and consists of a Board of Governors in Washington and twelve regional Reserve Banks. The Federal Open Market Committee conducts monetary policy and has twelve voting members: the seven governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents on a rotating basis. It meets eight times a year on a scheduled basis. Its statutory goals are maximum employment and stable prices — the dual mandate — and it has defined stable prices as 2 percent inflation over the longer run.

The Tools and Their Direction

The course expects you to know which way each tool moves for each policy stance. To expand: buy government securities on the open market, lower the discount rate, lower the reserve requirement, or lower the interest rate paid on reserve balances. To contract: sell securities, raise the discount rate, raise the reserve requirement, or raise the rate paid on reserves. Open market operations are described as the primary day-to-day tool. Note that the exam still uses the reserve requirement as a teaching device for the money multiplier even though it has not been the operative instrument in practice for some years — answer within the model the question is using.

Reserves, the Money Multiplier, and Balance Sheets

A standard free-response task gives a bank's simplified balance sheet and a required reserve ratio and asks for the amount of excess reserves, the maximum this bank can lend, and the maximum expansion of the money supply for the banking system as a whole. Work in that order. Excess reserves equal actual reserves minus required reserves. A single bank can lend at most its excess reserves. The banking system can expand deposits by excess reserves multiplied by the money multiplier, which is one divided by the required reserve ratio. State any assumptions the model makes — no cash leakage, no voluntary excess reserves — because questions sometimes ask why the actual expansion is smaller.

Key Terms to Know