Money Supply Process & Tools of Monetary Policy
ECON304-M01 — Money & Banking | Episode 6 (cont.): The Rise of a New Dawn
2026-05-06
“Inflation is always and everywhere a monetary phenomenon.”
— Milton Friedman, A Monetary History of the United States (1963)
Class Information
| Detail | Info |
|---|---|
| Course | ECON304-M01 — Money & Banking |
| Class # | 28 of 31 |
| Date | Wednesday, May 6, 2026 |
| Topic | Money Supply Process & Tools of Monetary Policy (Ch. 14–15) |
| Instructor | Dr. Meghan Downes (cmdownes@nmsu.edu) |
| Room | DOM 116, 11:00 AM – 12:15 PM |
Part 1: The Money Supply — Where Does Money Come From?
1.1 The Three Players
Money doesn’t come from nowhere. In the modern US banking system, three sets of actors interact to determine how much money exists in the economy — and each one has real power over the outcome.1
Note
The Three Players in Money Creation
The Federal Reserve — Sets the rules of the game. Controls the monetary base (high-powered money) through open market operations, the discount window, and reserve requirements. The Fed is the only entity that can create reserves from nothing.
Commercial Banks — Create deposits through lending. When a bank makes a loan, it creates a deposit — new money. The banking system as a whole multiplies the monetary base into a larger money supply. Banks’ decisions about how much to lend (and how much excess reserves to hold) affect the multiplier.
Depositors and Borrowers — Their behavior shapes the multiplier. When depositors hold more cash (rather than depositing it), the multiplier falls. When borrowers demand more loans, banks expand deposits. The “public’s” behavior is a critical third input.
Source: Mishkin,2 Ch. 14, pp. 359–363.
1.2 The Monetary Base (High-Powered Money)
The monetary base (MB) is the foundation on which the entire money supply rests. It is sometimes called “high-powered money” because each dollar of the base can support a multiple of dollars in bank deposits.
\[ MB = C + R \tag{1} \]
Where:
- C = Currency in circulation (cash held by the public — not in banks)
- R = Reserves (deposits banks hold at the Fed + vault cash)
The Fed controls the monetary base primarily through open market operations — buying and selling Treasury securities. When the Fed buys securities, it creates reserves (expanding MB). When it sells, it destroys reserves (contracting MB).
The Fed’s Balance Sheet — simplified:
| Assets | Liabilities |
|---|---|
| U.S. Treasury securities | Federal Reserve Notes (currency) |
| Mortgage-backed securities (MBS) | Reserve deposits of commercial banks |
| Loans to banks (discount window) | U.S. Treasury deposits |
| Foreign currency reserves | Capital |
When the Fed buys $100 billion in Treasuries, it credits the selling bank’s reserve account by $100 billion → MB increases by $100 billion. This is the fundamental mechanism behind all monetary expansion.
1.3 The Money Multiplier
The monetary base alone doesn’t determine how much money is in the economy. The money multiplier (m) converts the base into the broader money supply:
\[ M = m \times MB \tag{2} \]
The simple deposit multiplier (assuming no cash holdings and no excess reserves):
\[ m_{\text{simple}} = \frac{1}{rr} \tag{3} \]
If the reserve requirement is 10% (rr = 0.10), each dollar of base money supports $10 in deposits. But this is the theoretical maximum. In the real world, two “leakages” reduce the multiplier:
- Currency ratio (c): The fraction of deposits the public holds as cash rather than bank deposits. Cash in your wallet is not re-deposited, so it doesn’t support further lending.
- Excess reserve ratio (e): The fraction of deposits banks hold as reserves above the requirement. Banks holding excess reserves aren’t lending them out.
The realistic money multiplier:
\[ m = \frac{1 + c}{rr + e + c} \tag{4} \]
Where: - c = C/D (currency-to-deposit ratio) - rr = required reserve ratio - e = ER/D (excess reserve ratio)
| Scenario | rr | e | c | Multiplier | Implication |
|---|---|---|---|---|---|
| Textbook (no leakages) | 10% | 0% | 0% | 10.00 | $1 base → $10 deposits (theoretical max at 10% rr) |
| Pre-2008 typical | 10% | 1% | 35% | 2.93 | $1 base → $2.93 in M1 (realistic pre-crisis) |
| Post-2008 crisis (excess reserves spike) | 10% | 15% | 40% | 2.15 | $1 base → $2.15 (banks hoarding reserves; IOR incentive) |
| Post-2020 (rr = 0%, moderate excess) | 0% | 10% | 50% | 2.50 | $1 base → $2.50 (floor system; no formal rr) |
| Current 2026 (estimate) | 0% | 8% | 45% | 2.74 | $1 base → ~$2.76 (current estimate; QT environment) |
| Note: | |||||
| Multiplier calculated as m = (1+c)/(rr+e+c). Post-2020: rr = 0% by Fed policy (effective March 26, 2020). Source: Mishkin 13e, Ch. 14, pp. 369–378; FRED data. |
Important
Why the Post-2008 Multiplier Collapsed
After the Fed’s QE1 in late 2008, the monetary base roughly doubled — but the money supply barely moved. Why?
The Fed simultaneously introduced Interest on Reserves (IOR) in October 2008, paying banks interest on their deposits held at the Fed. Banks rationally chose to park trillions in excess reserves at the Fed rather than lend them out. The excess reserve ratio (e) spiked from ~0% to over 15%, collapsing the multiplier.
This means: large increases in the monetary base did NOT translate into proportional money supply increases. The feared hyperinflation from QE never materialized — because the money never entered circulation.
Source: Mishkin,3 Ch. 14, pp. 374–378; Ben S. Bernanke and Vincent R. Reinhart.4
Part 2: The T-Account Mechanics of Money Creation
2.1 Open Market Purchase — Step by Step
The clearest way to understand money creation is through T-accounts — the double-entry accounting tool that shows how balance sheets change.
Scenario: The Fed conducts an open market purchase — it buys $100 million in Treasury securities from a primary dealer’s bank account.
Step 1 — The Fed’s balance sheet:
| Federal Reserve — Assets | Federal Reserve — Liabilities |
|---|---|
| +$100M Treasury securities | +$100M reserves (bank deposit at Fed) |
Step 2 — The commercial bank’s balance sheet:
| Bank A — Assets | Bank A — Liabilities |
|---|---|
| −$100M Treasury securities | (no change — the dealer owned the bonds) |
| +$100M reserves at Fed |
Step 3 — Bank A lends out excess reserves (assuming banks want to hold only required reserves):
Under the old 10% reserve requirement, Bank A keeps $10M in required reserves and lends $90M.
| Bank A — Assets | Bank A — Liabilities |
|---|---|
| +$90M loan to Borrower | +$90M deposit (new money created) |
Step 4 — Borrower spends the money; it lands at Bank B:
Bank B receives a $90M deposit. It keeps $9M in reserves, lends $81M. And so on.
| Round | New Deposits ($M) | Reserves Held ($M) | New Loans Made ($M) | Cumulative M1 ($M) |
|---|---|---|---|---|
| 1 | $100.00M | $10.00M | $90.00M | $100.00M |
| 2 | $90.00M | $9.00M | $81.00M | $190.00M |
| 3 | $81.00M | $8.10M | $72.90M | $271.00M |
| 4 | $72.90M | $7.29M | $65.61M | $343.90M |
| 5 | $65.61M | $6.56M | $59.05M | $409.51M |
| 6 | $59.05M | $5.90M | $53.14M | $468.56M |
| 7 | $53.14M | $5.31M | $47.83M | $521.70M |
| 8 | $47.83M | $4.78M | $43.05M | $569.53M |
| ... | ... | ... | ... | ... |
| ∞ (sum) | $0.00M | $100.00M | $0.00M | $1,000.00M |
| Note: | ||||
| Each round: bank retains 10% as required reserves, lends 90%. Total expansion = $100M × (1/0.10) = $1,000M. In the current US system (rr = 0%), the theoretical multiplier is unlimited — bounded in practice by bank capital requirements, loan demand, and IOR incentives. Source: Mishkin 13e, Ch. 14, pp. 359–368. |
2.2 Why the Textbook Multiplier Doesn’t Work Perfectly
The T-account story above assumes banks immediately lend out all excess reserves. In practice, four frictions reduce the multiplier:
- Excess reserves: Banks hold more than required. Since 2008, IOR pays them to do so.
- Currency drain: When borrowers spend money, some of it becomes cash — never re-deposited.
- Capital constraints: Banks must maintain adequate capital ratios (Basel III), limiting lending.
- Loan demand: Even willing banks can’t create deposits without willing borrowers. Monetary policy can lead a horse to water…
Warning
The 2020–2022 M2 Puzzle — What Really Happened?
M2 grew from ~$15.4T in January 2020 to a peak of ~$21.7T in April 2022 — a 41% increase in 27 months. Then it contracted for the first time in modern history.
The expansion: Three sources acted simultaneously — (1) Fed QE added $4.5T to the balance sheet; (2) Treasury fiscal stimulus distributed ~$5T in checks directly to households (which became bank deposits); (3) the M1 definitional change added savings deposits.
The contraction: Starting in 2022, households drew down excess savings to fund consumption as inflation eroded purchasing power, and higher rates made holding cash costly. M2 fell ~$1T from peak.
Why this matters: Friedman was right that money growth drives inflation — but the lag was longer than expected (18–24 months), and the unprecedented combination of fiscal + monetary stimulus made the signal hard to read in real time.
Source: Milton Friedman and Anna Jacobson Schwartz;5 Mishkin,6 Ch. 14.
Part 3: The Fed’s Policy Toolkit — Four Main Tools
3.1 Open Market Operations — The Primary Instrument
Open market operations (OMO) are the Fed’s workhorse. The Federal Open Market Committee (FOMC) meets eight times per year and sets a target range for the federal funds rate — the rate at which banks lend reserves to each other overnight.
Note
OMO Mechanics — The Two Directions
Expansionary OMO: Fed buys Treasury securities → Banks receive reserves → Money supply increases → Fed funds rate falls (more reserves means banks charge less to lend them) → Lower borrowing costs → more investment and consumption → GDP growth
Contractionary OMO: Fed sells Treasury securities → Banks lose reserves → Money supply decreases → Fed funds rate rises (fewer reserves means banks charge more to lend them) → Higher borrowing costs → less investment and consumption → inflation cools
Modern implementation: The Fed no longer fine-tunes daily OMO to hit a precise fed funds rate. In the floor system (post-2008), it simply sets the Interest on Reserve Balances (IORB) rate — and the fed funds rate gravitates to that floor.
Source: Mishkin,7 Ch. 15, pp. 395–408.
3.2 The Discount Rate
The discount window is the Fed’s facility for lending directly to commercial banks. The rate charged is the discount rate (formally: the primary credit rate).
Key features of the discount window:8
- Primary credit — available to financially sound banks, typically at a spread above the fed funds rate target (currently ~50 bps above)
- Secondary credit — for financially distressed banks, at a higher spread; comes with greater scrutiny
- Seasonal credit — for smaller banks with seasonal funding needs (agriculture, tourism)
- Emergency credit (Section 13(3)) — extraordinary circumstances only; requires Treasury Secretary approval (used for TARP 2008, COVID 2020)
The Stigma Problem: Banks avoid the discount window because borrowing signals financial weakness. Counterparties see it as a red flag. This is why SVB and Signature Bank in March 2023 didn’t immediately access the discount window — the optics of borrowing from the Fed would have triggered the bank run they were trying to prevent.
Bagehot’s Rule (1873): Lend freely, at a penalty rate, against good collateral. The discount window is designed for exactly this purpose — but the stigma problem means it often fails at the worst moments.
| Period | Fed Funds Target (%) | Primary Credit Rate (%) | Spread (Primary - FF Mid) |
|---|---|---|---|
| 2015 (Jan) | 0.00–0.25 | 0.50 | +38 bps |
| 2017 (Jan) | 0.50–0.75 | 1.00 | +63 bps |
| 2018 (Dec peak) | 2.25–2.50 | 3.00 | +50 bps |
| 2019 (Dec) | 1.50–1.75 | 2.25 | +50 bps |
| 2020 (Mar — COVID cut) | 0.00–0.25 | 0.25 | +25 bps |
| 2020 (Apr) | 0.00–0.25 | 0.25 | +25 bps |
| 2022 (Jan) | 0.00–0.25 | 0.25 | +13 bps |
| 2022 (Mar — hike begins) | 0.25–0.50 | 0.50 | +25 bps |
| 2022 (Dec) | 4.25–4.50 | 4.50 | +25 bps |
| 2023 (Jul — peak) | 5.25–5.50 | 5.50 | +25 bps |
| 2024 (Sep — cut begins) | 4.75–5.00 | 5.00 | +25 bps |
| 2024 (Dec) | 4.25–4.50 | 4.50 | +25 bps |
| 2025–2026 (est.) | 3.75–4.25 | 4.25–4.50 | +25 bps |
| Note: | |||
| Primary credit rate is typically set 25–50 bps above the fed funds target midpoint. The smaller spread in early 2020 reflected emergency conditions. SVB collapse (Mar 2023) demonstrated the continued stigma of discount window borrowing. Source: Board of Governors of the Federal Reserve System; Mishkin 13e, Ch. 15, pp. 408–413. |
3.3 Reserve Requirements — Now Effectively Zero
Reserve requirements were once considered a primary tool of monetary policy. The logic was simple: raise the requirement, banks must hold more reserves, lending falls, money supply contracts.
In practice, reserve requirements were rarely changed because the disruption to bank portfolios was too severe. The last change before 2020 was in 1992.9
March 26, 2020: The Fed announced reserve requirements were reduced to 0% for all deposit categories, effective immediately.10
Why eliminate reserve requirements when you’re fighting a crisis? Because in the floor system, the fed funds rate is anchored by IORB — not by the quantity of reserves. Reserve requirements became a tax on banks that served no monetary policy function. Eliminating them freed up lending capacity at exactly the moment the economy needed it most.
| Date | Net Transaction Accounts | Non-personal Time Deposits | Policy Context |
|---|---|---|---|
| 1980 | 12% (>$25M); 3% (≤$25M) | 3% | Monetary Control Act of 1980 — extended Fed reserve requirements to all depository institutions |
| 1983 | 12% (>$26.3M); 3% (≤$26.3M) | 3% | Minor tranche adjustments under Monetary Control Act framework |
| 1990 (Nov) | 10% (>$41.1M); 3% (≤$41.1M) | 0% (eliminated) | Nontransaction deposits reserve requirement eliminated to ease credit |
| 1992 (Apr) | 10% (>$46.8M); 3% (≤$46.8M) | 0% | Further simplification — low-reserve tranche maintained |
| 1993 | 10% (>$52.0M); 3% (≤$52.0M) | 0% | Routine annual tranche adjustment |
| 2020 (Mar 26) | 0% — ALL deposits | 0% | COVID-19 response. Fed shifted to 'floor system' — IOR makes reserve requirements redundant |
| Note: | |||
| Source: Board of Governors of the Federal Reserve System, Reserve Requirements page (https://www.federalreserve.gov/monetarypolicy/reservereq.htm); Federal Reserve Press Release, March 15, 2020 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm). Monetary Control Act of 1980 citation: Mishkin 13e, Ch. 15, pp. 413–417. |
Note
The PanOpticon Connection: Logan’s Reserve Taxation
In Logan Prime’s Central Credit Bureau, loan officers were required to hold 40% of all allocations as “compliance reserves” — idle credits that earned no return, extracted as a de facto tax by the Bureau.
The result was exactly what the textbook predicts: the effective multiplier was less than 2.5. Projects that should have been funded weren’t. Citizens bore the cost of Logan’s control mechanism as a permanent drag on output.
The new CBF under Patsy’s direction immediately eliminated compliance reserves. The multiplier effect of freed capacity financed twelve new infrastructure projects in the first quarter.
The lesson: reserve requirements (and their equivalents) are never “free.” Someone pays the opportunity cost.
3.4 Interest on Reserve Balances (IORB) — The Modern Tool
Interest on Reserve Balances (IORB) is the interest rate the Fed pays commercial banks on the reserves they hold in their Federal Reserve accounts. Authorized by the Emergency Economic Stabilization Act of 2008, it became the Fed’s primary policy rate.
Why IORB is the dominant tool today:
The IORB creates a floor for the federal funds rate. Here’s the arbitrage logic:
If the fed funds rate fell below IORB, no bank would lend reserves in the federal funds market — they’d just earn the guaranteed IORB instead. This keeps the fed funds rate at or above IORB.
Combined with the Overnight Reverse Repo (ON RRP) facility (which allows money market funds and other non-bank institutions to earn a near-zero-risk return), the system creates a corridor:
\[ i_{\text{ON RRP}} \leq i_{\text{FF}} \leq i_{\text{IORB}} \tag{5} \]
Important
How the Fed Raises Rates in the Floor System
Under the old corridor system, the Fed would sell securities to drain reserves and push up the fed funds rate.
Under the floor system, the Fed simply announces a higher IORB rate. Banks won’t lend below IORB (they’d lose money vs. holding at the Fed), so the entire market rate complex adjusts upward — instantly, and without the Fed having to move a single security.
This is why the 2022 hiking cycle moved so quickly: 75 bps per meeting was mechanically simple in the floor system. The Fed set the new IORB rate and it was done.
Source: Mishkin,11 Ch. 15, pp. 417–426; Darrell Duffie and Arvind Krishnamurthy.12
3.5 Quantitative Easing (QE) and Quantitative Tightening (QT)
Quantitative Easing (QE) is large-scale asset purchasing beyond normal OMO, targeting long-term interest rates when the short-term rate is at (or near) zero. The Fed buys Treasuries and mortgage-backed securities at the long end of the curve, pushing down 10-year and 30-year rates directly.
Quantitative Tightening (QT) is the reverse: the Fed allows its balance sheet to shrink by not reinvesting proceeds from maturing bonds. The Fed has also occasionally sold securities outright.
Why QE was necessary in 2008 and 2020:
The traditional tool (cutting the fed funds rate) hits a wall at 0% — the zero lower bound. You cannot meaningfully set rates below zero (in the US context). QE allows the Fed to provide additional stimulus through quantity of money creation rather than price (interest rates).
The 2026 Context:
The Fed is conducting simultaneous QT and rate cuts — an unusual combination. QT reduces the balance sheet (and long-term rate support) while rate cuts ease short-term borrowing costs. The reason: the Fed wants to normalize the balance sheet while also responding to a slowing economy, but doesn’t want to prematurely unwind all of 2022’s tightening.
The China Stress Scenario: China holds approximately $750–800 billion in US Treasuries.13 If China were to sell a significant portion — as a geopolitical lever — it would add supply to the Treasury market, pushing yields up. The Fed could partially offset this with OMO (buying Treasuries to absorb supply), but a large-scale sale would challenge the Fed’s ability to maintain its yield targets without expanding its balance sheet again.
Part 4: Stress Testing the Toolkit — ROI Game Scenarios
Connect today’s concepts to the ROI Game portfolio you’re managing. The five scenarios below represent plausible 2026 monetary policy environments.
| Scenario | First-Order Effect | Fed Tool Response | Impact on Your Portfolio |
|---|---|---|---|
| 1. Fed raises rates 200 bps (hawkish surprise) | Bond prices fall (duration mismatch) — SVB 2023 redux. Long-duration portfolios hit hardest. | Fed may slow hiking via forward guidance; potentially reverse with OMO if recession signals emerge. | Fixed-income holdings lose value; floating-rate assets benefit. Review your bond duration exposure from Class #20. |
| 2. Private credit failure (shadow bank run) | Credit multiplier collapses — private lending channels freeze. Bank stocks fall, spreads widen. | Section 13(3) emergency lending; potentially expanded discount window access for NBFIs. | Private credit funds mark down; bank equity exposed. Diversification into Treasuries provides offset. |
| 3. Banks misread Fed forward guidance (adverse selection meets OMO) | Banks price in rate cuts that don't arrive — loan books mispriced. NIM compressed. | Fed publishes detailed dot-plot guidance; uses IORB adjustments to signal intent clearly. | Bank stocks exposed to NIM compression. REITs and long-duration bonds benefit if cuts eventually arrive. |
| 4. China sells $1T in US Treasuries (geopolitical OMO stress) | Long-end Treasury yields spike — mortgage rates surge, housing market seizes. | Targeted OMO (buy Treasuries) to absorb supply; coordinate with Treasury buyback program. | MBS and mortgage-adjacent assets hurt most; short-duration Treasuries relatively safe. |
| 5. AI-driven productivity boom (positive supply shock) | Real r* rises — neutral rate higher. Current fed funds rate is expansionary even at 3.5%. | Taylor Rule recalibration — raise target rate toward new neutral; dot plots shift up. | Growth equities and tech benefit from productivity; bonds sell off as r* rises. |
| Note: | |||
| Scenarios are illustrative for portfolio stress testing. Duration concepts: Mishkin 13e, Ch. 3 and Class #20 materials. Taylor Rule preview: Mishkin 13e, Ch. 16 (Class #30). China Treasury holdings: U.S. Treasury TIC data (https://home.treasury.gov/data/treasury-international-capital-tic-system). |
Part 5: The PanOpticon Storyline — Episode 6: “The New Dawn Toolkit”
The Gladiator’s discomfort is the right response. The dual mandate forces the Fed to make value judgments that pure optimization cannot resolve. This is why central bank independence matters — and also why it has limits. The FOMC is appointed by elected officials. The weights are set, implicitly, by democratic process.
The key CBF design decisions:
- Floor system adopted — IORB replaces reserve requirements as the binding constraint on banks
- Inflation target: 2% — symmetric; the new CBF explicitly commits to not tolerating below-target inflation as acceptable
- Reserve requirements: 0% — but capital requirements (equity buffer) ensure banks have skin in the game
- Discount window: stigma reduction program — the new CBF offers anonymous emergency credit with a 24-hour delay before public disclosure (reducing stigma without eliminating transparency)
- Loss function weights: λ = 1 — equal weight on inflation and employment gaps, publicly announced
The Gladiator, who spent years optimizing Logan’s compliance scores with false precision (“11 decimal places measuring nothing”), now optimizes a real loss function — one where every parameter choice is accountable to the citizens it serves.
Part 6: Key Equations & Reference Sheet
| # | Concept | Equation / Statement | Source |
|---|---|---|---|
| 1 | Monetary Base | MB = C + R | Mishkin 13e, Ch. 14, p. 362 |
| 2 | Simple Money Multiplier | m = 1 / rr | Mishkin 13e, Ch. 14, p. 365 |
| 3 | Full Money Multiplier | m = (1 + c) / (rr + e + c) | Mishkin 13e, Ch. 14, pp. 369–374 |
| 4 | Money Supply | M = m × MB | Mishkin 13e, Ch. 14, p. 375 |
| 5 | OMO Effect on Money Supply | ΔM = m × ΔMBO (where ΔMBO = open market operation change in MB) | Derived from Ch. 14 |
| 6 | Fed Funds Rate Floor Condition | i_ff ≥ IORB (arbitrage: no bank lends below what the Fed pays on reserves) | Mishkin 13e, Ch. 15, pp. 417–420 |
| 7 | Real Federal Funds Rate | r_ff = i_ff − π | Mishkin 13e, Ch. 4 (Fisher equation) |
| 8 | Taylor Rule (Preview: Class #30) | i_ff = r* + π + 0.5(π − π*) + 0.5(y − y*) | Taylor (1993); Mishkin 13e, Ch. 16 (preview) |
| 9 | Fed Balance Sheet Identity | Assets = Liabilities + Capital (as always — the Fed is not exempt from accounting) | Mishkin 13e, Ch. 14, pp. 359–362 |
| 10 | Central Bank Loss Function | L = (π − π*)² + λ(u − u*)² | Mishkin 13e, Ch. 16; standard macroeconomics |
| Note: | |||
| Equation (8) (Taylor Rule) previews Class #30 material — Inflation Targeting and the Dot Plot (May 13). Equation (10) loss function: the parameter λ determines the relative weight on inflation vs. employment stabilization. Mishkin 13e covers Taylor Rule in Ch. 16; loss function is standard central bank macroeconomics. |
Discussion Questions
The multiplier myth: If reserve requirements are 0%, does the money multiplier still exist? What actually limits bank lending in the current US system? (Think about capital requirements, IOR incentives, and loan demand — and be precise about which of these is binding in 2026.) (Mishkin Ch. 14, pp. 365–378)
OMO mechanics: Walk through exactly what happens to the Fed’s balance sheet, the banking system’s balance sheet, and the money supply when the Fed buys $500 billion in Treasuries. Use T-accounts. At what point does “money creation” actually occur? (Mishkin Ch. 14, pp. 359–368; Ch. 15, pp. 395–408)
IORB as a floor: Why can’t the fed funds rate fall below IORB? Construct the arbitrage argument carefully. If a money market fund offers 5.2% and IORB is 5.25%, where does the fed funds rate trade — and why? What does the ON RRP rate add to the picture? (Mishkin Ch. 15, pp. 417–426)
The China scenario: China holds approximately $750–800 billion in US Treasuries. If China sells $500 billion in a geopolitical pressure campaign, what are the first-order effects on Treasury yields, mortgage rates, and the dollar? Can the Fed fully offset this with OMO? What are the constraints? (Mishkin Ch. 15; U.S. Department of the Treasury14)
QE and inequality: Does quantitative easing benefit everyone equally? Consider: (a) asset-price effects (who holds assets?), (b) employment effects (who benefits from lower unemployment?), (c) inflation effects (who bears higher prices?). Does the dual mandate implicitly address distributional concerns — or ignore them? (Mishkin Ch. 14–15; Friedman & Schwartz 1963)
Your ROI portfolio: Which of your current ROI Game investments is most sensitive to a 100 basis point surprise increase in the fed funds rate? Use the duration concept from Class #20 to estimate the price impact. What would you do to hedge this exposure? (Class #20 duration materials; Mishkin Ch. 3–4)
Storyline Bridge: What Comes Next
References
Bernanke, Ben S., and Vincent R. Reinhart. “Conducting Monetary Policy at Very Low Short-Term Interest Rates.” American Economic Review: Papers and Proceedings 94, no. 2 (2004): 85–90. https://doi.org/10.1257/0002828041301972.
Board of Governors of the Federal Reserve System. Federal Reserve Actions to Support the Flow of Credit to Households and Businesses. Press Release, 2020. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm.
Duffie, Darrell, and Arvind Krishnamurthy. Passthrough Efficiency in the Fed’s New Monetary Policy Setting. Federal Reserve Bank of Kansas City (Jackson Hole Symposium), 2016. https://www.kansascityfed.org/Jackson%20Hole/documents/6087/Duffie_final.pdf.
Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867–1960. Vol. 12. National Bureau of Economic Research Studies in Business Cycles. Princeton University Press, 1963.
Mishkin, Frederic S. The Economics of Money, Banking and Financial Markets. 13th ed. Pearson, 2022.
U.S. Department of the Treasury. Major Foreign Holders of Treasury Securities. Treasury International Capital (TIC) Data, 2025. https://home.treasury.gov/data/treasury-international-capital-tic-system.
Footnotes
Frederic S. Mishkin, The Economics of Money, Banking and Financial Markets, 13th ed. (Pearson, 2022), Ch. 14, pp. 359–363.↩︎
“Conducting Monetary Policy at Very Low Short-Term Interest Rates,” American Economic Review: Papers and Proceedings 94, no. 2 (2004): 85–90, https://doi.org/10.1257/0002828041301972.↩︎
A Monetary History of the United States, 1867–1960, vol. 12, National Bureau of Economic Research Studies in Business Cycles (Princeton University Press, 1963).↩︎
Mishkin, The Economics of Money, Banking and Financial Markets, Ch. 15, pp. 408–413.↩︎
Mishkin, The Economics of Money, Banking and Financial Markets, Ch. 15, pp. 413–417.↩︎
Board of Governors of the Federal Reserve System, Federal Reserve Actions to Support the Flow of Credit to Households and Businesses, Press Release, 2020, https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm.↩︎
Passthrough Efficiency in the Fed’s New Monetary Policy Setting (Federal Reserve Bank of Kansas City (Jackson Hole Symposium), 2016), https://www.kansascityfed.org/Jackson%20Hole/documents/6087/Duffie_final.pdf.↩︎
U.S. Department of the Treasury, Major Foreign Holders of Treasury Securities, Treasury International Capital (TIC) Data, 2025, https://home.treasury.gov/data/treasury-international-capital-tic-system.↩︎