Easy Money Policy

This monetary policy is used when the economy is faced with recession and unemployment.

Components:

1. Buy Securities from commercial banks and public

• This increases the supply of money.  The Federal Reserve is getting bonds, something which isn't money, and exchanging it for money.  Hence, there is more money circulating in the economy.

• Because banks now have more reserves, they are able to make more loans to the public.

2. Reduce the Federal Funds Rate

• By lowering the Federal Funds rate, it costs less interest for banks to borrow from other banks.  Thus, banks have more excess reserves and lend more to the public.

3. Lowering the Discount Rate

• Commercial banks loaning from the Federal Reserve now have more excess reserves.  Therefore, they can loan more money to the public.

4. Reduce the Reserve Ratio

• By lowering the reserve ratio, banks now have more excess reserves.  Therefore, money supply has been increased, and the banks are able to lend more money to the public.

Effects of Changing Money Supply on Aggregate Demand

Increasing the Supply of Money

1. interest rates fall

2. investment rises

3. aggregate demand rises

The steeper the Dm curve, the larger the effect of any given change in the money supply on the equilibrium rate of interest.  Furthermore, any given change in the interest rate will have a larger impact on investment - and hence a greater impact on aggregate demand and GDP.

As a side note, an easy money policy increases net exports because of smaller interest rates.

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