Page 307 - Krugmans Economics for AP Text Book_Neat

figure 27.2 Open-Market Operations by the Federal Reserve

(a) An Open-Market Purchase of $100 Million (b) An Open-Market Sale of $100 Million

Assets Liabilities Assets Liabilities Section 5 The Financial Sector
Federal Treasury +$100 Monetary +$100 Federal Treasury –$100 Monetary –$100
Reserve bills million base million Reserve bills million base million

Assets Liabilities Assets Liabilities
Commercial Treasury –$100 No change Commercial Treasury +$100 No change
banks bills million banks bills million
Reserves +$100 Reserves –$100
million million

In panel (a), the Federal Reserve increases the monetary base by duces the monetary base by selling U.S. Treasury bills to private
purchasing U.S. Treasury bills from private commercial banks in commercial banks in an open-market operation. Here, a $100 million
an open-market operation. Here, a $100 million purchase of U.S. sale of U.S. Treasury bills leads to a $100 million reduction in com-
Treasury bills by the Federal Reserve is paid for by a $100 million mercial bank reserves, resulting in a $100 million decrease in the
increase in the monetary base. This will ultimately lead to an in- monetary base. This will ultimately lead to a fall in the money supply
crease in the money supply via the money multiplier as banks lend via the money multiplier as banks reduce their loans in response to a
out some of these new reserves. In panel (b), the Federal Reserve re- fall in their reserves.

The change in bank reserves caused by an open -market operation doesn’t directly af-
fect the money supply. Instead, it starts the money multiplier in motion. After the $100
million increase in reserves shown in panel (a), commercial banks would lend out their
additional reserves, immediately increasing the money supply by $100 million. Some
of those loans would be deposited back into the banking system, increasing reserves

fyi

Who Gets the Interest on the Fed’s Assets?
As we’ve just learned, the Fed owns a lot of its operations but turns most of it over to the U.S. the size of the monetary base based on eco-
assets—Treasury bills—which it bought from Treasury. For example, in 2009 the Federal Re- nomic considerations—in particular, the Fed
commercial banks in exchange for the mone- serve System received $52.1 billion in income— doesn’t let the monetary base get too large be-
tary base in the form of credits to banks’ re- largely in interest on its holdings of Treasury cause that can cause inflation. So every fake
serve accounts. These assets pay interest. Yet bills, of which $46.1 billion was returned to $100 bill that enters circulation basically means
the Fed’s liabilities consist mainly of the mone- the Treasury. that the Fed prints one less real $100 bill. When
tary base, liabilities on which the Fed doesn’t We can now finish the story of the impact of the Fed prints a $100 bill legally, however, it gets
pay interest. So the Fed is, in effect, an institu- those forged $100 bills allegedly printed in North Treasury bills in return—and the interest on
tion that has the privilege of borrowing funds at Korea. When a fake $100 bill enters circulation, those bills helps pay for the U.S. government’s
a zero interest rate and lending them out at a it has the same economic effect as a real $100 expenses. So a counterfeit $100 bill reduces the
positive interest rate. That sounds like a pretty bill printed by the U.S. government. That is, as amount of Treasury bills the Fed can acquire and
profitable business. Who gets the profits? long as nobody catches the forgery, the fake bill thereby reduces the interest payments going to
You do—or rather, U.S. taxpayers do. The Fed serves, for all practical purposes, as part of the the Fed and the U.S. Treasury. So taxpayers bear
keeps some of the interest it receives to finance monetary base. Meanwhile, the Fed decides on the real cost of counterfeiting.

module 27 The Federal Reserve: Monetary Policy 265