Monetary Policy
Download
Report
Transcript Monetary Policy
Monetary Policy
I. Federal Reserve System
1913
12 District Reserve Banks (a la Federal
District Courts)
Janet Yellen (Chairman Federal Reserve
Board of Governors) monetary policy:
actions Fed takes to influence level real
GDP and rate of inflation
Goals of Monetary Policy
Not profit motivated
“assist in achieving a full-employment,
noninflationary level of total output”
1960s: focus full-employment
Post-1970s: focus inflation
Alters M by altering excess reserves to
affect output and prices
Theory of Monetarism
MV≡PY
Money supply x Velocity = Price Level x
Output = nominal GDP
Assumes velocity relatively fixed (slow,
predictable change)
II. Tools
1) Open Market Operations
Buying and selling of bonds in open market
Buying
From C. Banks: increases banks’ reserves by amount
of purchase (if fully “loaned up” $1000 bond
w/20% RR $5000 increase lending + M)
From public: indirectly increases banks’ reserves (less
the reserve requirement: $4000 in lending and $1000
in new demand deposit= $5000 increase M)
Selling: just the reverse
2) Reserve Ratio
Raise RR A) lose excess reserves
diminish money creation through lending
or B) reserves become deficient contract
checkable deposits and therefore M
Lowering has opposite effect
∆ RR: 1) ∆ excess reserves and 2) ∆
monetary multiplier (1/RR)
3) Discount Rate
Commercial Bank borrowing from Fed
increase reserves extension credit
Discount rate: rate charged to borrow
from Fed (cost of acquiring reserves)
raise/lower discourages/encourages C.
Bank borrowing to increase M
4) Moral Suasion
Speeches, interviews, etc.: try to persuade
people to change behavior so Fed doesn’t
have to act
“Irrational exuberance”
Easy vs. Tight Policy
Expand M: buy securities, reduce RR,
lower discount rate
Restrict M: sell, raise, raise
Relative Importance of Tools
#1 Open market operations (bonds)
Discount rate: 1) C. Banks borrow only 2-3% of
reserves from Fed (and OMO changes in
borrowing); 2) DR effectiveness dependent on
bank decisions (if banks unwilling, Fed unable)
But, discount rate as “announcement effect”; but
often to keep in line w/other rates
Reserve ratio: used rarely bc impacts bank
profits (reserves earn no interest)
OMO: 1) flexible (scalpel >
sledgehammer); 2) prompt (timing
problems); 3) powerful: total sale could
take reserves $22B $0
Washington Baby-Sitter Co-op Redux
III. Monetary Policy, Real GDP,
Price Level
Money Demand
Transaction demand: to use
Asset demand: to hold
Factors affecting: 1) cash needed on
hand, 2) interest rates (opp’y cost of
holding money), 3) price levels, 4) general
level of income
Investment Demand
Amount investment w/rate of return
greater than real rate of interest
∆M ∆i.r. ∆I ∆GDP + PL
Effectiveness
1) Speed and flexibility
2) isolation from political pressure
3) “Success” in 1980s + 1990s (Greenspan
the “maestro”) monetary policy primary
stabilization tool in US
Some now criticize Greenspan for allowing
bubbles (stocks + housing) to form
Shortcomings and Problems
1) Less control? ∆ banking + globalization undermine Fed
policy power
2) Cyclical assymetry: easy money only works if
willing to loan/borrow: Fed strong in expansions,
weaker in recessions (when arguably most needed)
∆ biz confidence (movement of investment demand curve) may
require enormous exertions by Fed to offset
3) Changes in velocity: total expenditures = M times
velocity of money (how often spent)
4) Investment Impact: in reality borrowing small source
investment (mostly retained earnings)
5) Interest as income: MP based on assumption
expenditures inversely related i; but i also income, so
direct relationship (probably only partly off-sets)
6) Zero-lower bound: what if interest rates are 0%?
Federal Funds rate
Rate banks charge other banks for shortterm loans (cover reserve requirements)
“target”: not set by Fed (supply and
demand), but buys/sells bonds to affect
rate
Prime rate follows Federal Funds
Policy Multipliers
Spending Multiplier: 1/MPS
Actual multiplier estimated at 2x
Taxing Multiplier: 1xMPC (=.95)
Balanced Budget Multiplier (equal tax hike
and spending hike): 1x change G
Money Multiplier: Excess Reserves x
1/RRR
Monetarism: MV=PY ∆M x V = ∆GDP