Monetary policy: limited and ample reserves

Learning objectives

State the goals of monetary policy (price stability and maximum employment) and explain the role of the central bank as the institution that controls the money supply and the policy interest rate

Describe the tools of monetary policy under a limited reserves framework (open market operations, the discount rate and the reserve requirement) and show their effects on the money market graph

Explain how the central bank operates under an ample reserves framework by adjusting administered rates (interest on reserves and the discount rate), and show this on a reserve market graph where the supply of reserves meets the flat section of reserve demand

Show how expansionary monetary policy lowers the interest rate, raises investment and interest-sensitive consumption, shifts AD to the right and closes a recessionary gap, and how contractionary policy does the reverse

Trace the full transmission mechanism with a chain of correctly labeled graphs: money or reserve market → interest rate → investment → AD–AS → real output and price level

Evaluate the limitations of monetary policy, including time lags, the zero lower bound and uncertainty about how strongly interest rates affect spending