tailieunhanh - Ten Principles of Economics - Part 61

Ten Principles of Economics - Part 61. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 27 THE MONETARY SYSTEM 621 system which in turn reduces the money supply. Conversely a lower discount rate encourages bank borrowing from the Fed increases the quantity of reserves and increases the money supply. The Fed uses discount lending not only to control the money supply but also to help financial institutions when they are in trouble. For example in 1984 rumors circulated that Continental Illinois National Bank had made a large number of bad loans and these rumors induced many depositors to withdraw their deposits. As part of an effort to save the bank the Fed acted as a lender of last resort and loaned Continental Illinois more than 5 billion. Similarly when the stock market crashed on October 19 1987 many Wall Street brokerage firms found themselves temporarily in need of funds to finance the high volume of stock trading. The next morning before the stock market opened Fed Chairman Alan Greenspan announced the Fed s readiness to serve as a source of liquidity to support the economic and financial system. Many economists believe that Greenspan s reaction to the stock crash was an important reason why it had so few repercussions. PROBLEMS IN CONTROLLING THE MONEY SUPPLY The Fed s three tools open-market operations reserve requirements and the discount rate have powerful effects on the money supply. Yet the Fed s control of the money supply is not precise. The Fed must wrestle with two problems each of which arises because much of the money supply is created by our system of fractional-reserve banking. The first problem is that the Fed does not control the amount of money that households choose to hold as deposits in banks. The more money households deposit the more reserves banks have and the more money the banking system can create. And the less money households deposit the less reserves banks have and the less money the banking system can create. To see why this is a problem suppose that one day people begin to lose confidence in the banking .

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