Capital Budgeting Memo

To:

From:

Re: Monetary Policy Recommendations

Date:

The Monetary Policy Simulation demonstrates the impact of monetary policy upon the U.S. economy. Acting as the Chairman of the Federal Reserve, you are charged with directing the nation's economy for ten years. There are three economic indicators that are monitored to evaluate the economy. These indicators are the Real Gross Domestic Product (GDP), the Inflation Rate and the Unemployment Rate. The tools that are at your disposal include the ability to adjust the Federal Funds Rate (FFR), the Discount Rate (DR) and the Required Reserve Ratio (RRR). In addition, you have control of the Open Market Operation (OMO) through the buying and selling of bonds, t-bills and other federal instruments. As you move through the ten-year period, the economy is affected by an Asian import threat, an increase in the minimum wage, an increase in Defense spending, a European economic crisis, a tax cut, and a trade embargo. Th ability to control the money supply to counteract these issues is the key to ensuring that GDP, inflation and unemployment stay at acceptable levels.

The simulation demonstrated how changes in the DR/FFR spread, the RRR, and the OMO affect the money supply in our economic system. Summaries of these effects are as follows:

* The spread between the DR and the FFR affects the amount of money that is available in the economic system. As the DR is decreased, thereby creating or increasing the spread between the DR and the FFR, banks will begin borrowing money from the Fed rather than other banks. This will release more money into the system. On the contrary, if the DR is raised above the FFR, banks will be encouraged to borrow from each other, which will not affect the money supply.

* The RRR is the percentage of deposits that a bank must hold as reserves and not available for use in the system. As this rate is raised, banks must hold more in reserves and the money supply decreases. If the rate is lowered, banks can use the released money in the system.

* Control of the OMO is gained through either purchasing or selling federal instruments such as t-bills and bonds into and out of the market. As the Fed buys these instruments, money is released into the system. The reverse

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