Money Creation and Open Market Operations.

a. Briefly explain in words how the “money multiplier” is supposed to work (i.e., how, under the “textbook view” of banking operations, a Fed purchase of Treasury securities is said to result in a multiplied expansion of the quantity of money in circulation). You may want to refer to Wright (2012) sections 14.2–14.3 (pg.313–321). What does Wright say are the limitations of this model of money creation? Also, discuss what options a bank would have if they had a lending opportunity, but didn’t have the reserves available for payment of the loan; what does this mean for the money multiplier story?

b. As we discussed in class, the Fed has not used money supply targets as a basis for open market operations since the early 1980s. What does the Fed use as a target instead? What actions does the Fed take to achieve this target?