Monetary Policy and Financial Institutions

Asset Demand

Money held as an asset (e.g., under the mattress) is influenced by the risks associated with such storage and inflation rates.

Banking

Banking involves various financial institutions transferring funds from lenders to borrowers.

Main Financial Institutions

Primarily commercial banks, but also:

1. Savings and Loan Institutions (SLs): Smaller scale, typically locally focused.
2. Insurance Companies: Life insurance policies involve ongoing deposits, with the insurance company returning funds with interest if the policyholder doesn't die. Thus, insurance companies actively facilitate lending to firms.
3. Mutual Funds: Pool household savings, managed by experts, offering diverse products to different customers.
4. Pension Funds: Supplement social security, allowing individuals to maintain their lifestyle after retirement. Similar to mutual funds but may focus on specific companies, though they cannot invest the majority of their resources in a single company.

Objectives of Central Banks

1. Stable Prices: Controlling inflation.
2. Low Unemployment
3. Rapid Growth of Real GDP

Instruments of Monetary Policy

1. Reserve Requirements: The Central Bank can reduce the money supply if it deems it excessive.
2. Discount Rates: The Official Discount Rate (ODR) is the interest rate charged by the Central Bank to commercial banks and other depository institutions for loans.
3. Open Market Operations (Buying/Selling Treasury Bills): Not explicitly mentioned in the original text, but implied by later discussion.

Boosting the Economy

1. Decrease Reserve Requirements: Increases the Money Supply Multiplier.
2. Buy Treasury Bills: Injects money into the economy.
3. Decrease Interest Rates: Simultaneously increases consumption and investment.

Slowing the Economy

1. Sell Treasury Bills: Reduces bank reserves.
2. This reduces the money supply, causing interest rates to rise.
3. Higher interest rates decrease investment and consumption.
4. Reduced investment and consumption decrease Real GDP (production).