Transcript Monetary Policy

Monetary Policy
Chapter 13
Federal Funds Rate
Ms
i
Supply
Money
Reserves
ffro
i0
Md
Demand
$
Reserves
Supply
P0
Price Level
AS
Goods and
Services
Bonds
P0
Demand
AD
GDP
GDP
National
Income
Demand for Money (Md):
The amount public wants
to hold in liquid form
Households
Does not earn Interest
Stocks, Funds
Bonds, CD’s,
Life Insurance
Md Depends
Buy
on
dollar
Need
in
Deposits
goods
value
of
liquid
form
and
Cash
and
transactions
d
services
M
Earns Interest
Money Supply Ms: Amount the public actually
holds (Deposits & Cash)
Ms
500b
Ms 0
Public wants less
cash: looking for
borrowers who
would pay interest
At 3%:
: the Public
holds the
amount it
to
hold
Federal Funds Rate
Supply
ffro
Reserves
Demand
Federal Funds Rate
Reserves
MARKET FOR RESERVES
Banks’ Demand for
depends on
Banks’ Demand
for
depends on size
of
:
= r*
Banks’ Demand
for
depends on
Federal Funds Rate
Supply
When GDP or
Prices increase,
Bank’s Demand
for Reserves shifts
right and ffr
increases
ffr1
Reserves
ffro
Demand
Reserves
Federal Funds Rate
MARKET FOR RESERVES
Inverse Relationship Between
Price of Bonds and Interest Rate
Amount you
get at maturity
25%
11%
Interest
=
rate
-
Price you
paid for
Bond
$90
$80
$100
Price you paid for
Bond
$90
$80
The lower the price on the bond, the higher
the interest rate.
Market for Reserves: Fed Buys Bonds
Federal funds Rate
Supply= excess
reserves + Fed
changes
ffro
ffr1
Demand: Banks +
Public
Money
Supply:
Government
and Fed
Bonds
P0
Demand:
Public
Price of Bonds
MARKET FOR BONDS
Bond Market: Fed Buys Bonds
When the fed
buys bonds it
decreases the
supply of
bonds
available to the
public….
Bond Market: Fed Buys Bonds
Supply of bonds
i1=4%
P1
P0
Bond Price
rises: Interest
Rates
Decrease
i0 =8%
Demand for bonds
Interest Rate and Velocity of Money
As interest rate rise, public holds less
Velocity of money: Number
cash for transactions: each dollar is
of times a dollar bill is used
used more times.
Dollar value of
what we buy
Ms = Deposits +
currency
Velocity = Nominal GDP/Ms
Contractionary Policy: interest rate rise,
public holds less cash and deposits
(Ms):Velocity increases
I increase
AE line Shifts up
AD shifts Right
Aggregate Expenditures
45
Price level
P0
The size of the change in
equilibrium Y
Y0
Y1
Equilibrium Income increase
Prices are the same
AD1
Is the size of the shift in
AD
AD0
Y0
Y1
Price Level
AS
Goods
and
Services
P0
AD
AD = C + I + G + NX
GDP0
GDP
Price Level
GOODS AND SERVICES
Fed Buys Bonds: Interest rate
drops, Investment Increase
Price Level
AS
AD shifts Right
Prices
Rise
AD1 = C0 + I1=G0+NX0
AD0 = C0 +
I =G +NX
0
0
GDP
GDP Increase
0
When the Fed Wants to Reduce
Unemployment
Use Expansionary Monetary Policy
Buy Bonds
Increase Reserves and Money Supply
Decrease d
Decrease r
Decrease the interest rate.
Increase Investment
Increase Aggregate Demand for goods and
services
s
Banks
may
Fed Controls
Reserves
but
not
the
M
may
OMO: What can goPublic
wrong?
not want to
Loans are lend
not deposited
Fed buys
in the
bonds banking
from
the public
or
system
banks
not want to
borrow
Fed increases
banking system
reserves
Money Supply Increases
Deposits
Increase
Loans
Increase
Banks
increase
loans
Interest Rates
decrease
Credit easier
to get
27
Open Market Operations: Fed
Buys Bonds
Fed buys
bonds from the
public or banks
Fed increases
banking system
reserves
Money Supply Increases
Deposits
Increase
Loans
Increase
Banks
increase
loans
Interest Rates
decrease
Credit easier
to get
28
Open Market Operations: Fed
Buys Bonds
Fed buys
bonds to
the public
or banks
Fed increases
banking system
reserves
Banks
increase
loans
Aggregate demand
Increase
Investment
increases
Interest Rates
decrease
Credit easier
to get
29
Market for Reserves: Fed Sells Bonds
Federal funds Rate
Supply= excess
reserves + Fed
changes
ffr1
ffro
Demand: Banks +
Public
Money
Open Market Operations: Fed
Sells Bonds
Fed sells
bonds to
the public
or banks
Fed reduces
banking system
reserves
Money Supply Decreases
Deposits
Decrease
Banks
decrease
loans
Interest Rates
increase
Loans
Decrease
Credit harder
to get
31
The Money Market: Fed Sells Bonds
Money scarce: Everyone needs to borrow cash:
willing lenders can be
found only at higher interest
s
M0
Ms1
rate.
Reserves, Loans,
Deposits and the Ms
decrease
i
i =5%
Amount
of
Money
the
Amount
of checking
Money the
the
Money
into
Amount
of
Money
Public
holds
in
deposit
Public
in
accounts:
look for
willing
Public holds
holds
in deposit
deposit
accounts
= Amount
accounts
<
the
lenders
accounts
= Amount
Amount
the
the public
wants
to
public
wants
to
public
wants
to hold
hold
hold
when
i0 =3%
when
i00 =3%
when
=5%
0
i =3%
0
$
Ms1
M d0
Open Market Operations: Fed
Sells Bonds
Fed sells
bonds to
the public
or banks
Fed reduces
banking system
reserves
Banks
decrease
loans
Aggregate demand Drops
Investment
Decrease
Interest Rates
increase
Credit harder
to get
33
Price Level
Fed Sells Bonds
AS
Prices
Drop
AD0 = C0 +
I =G +NX
0
0
AD1 = C0 + I1=G0+NX0
GDP Decrease
Real GDP
0
Bond Market: Fed Sells Bonds
i =25%
i =11%
Supply of bonds: Fed, government
Bond Price
falls: Interest
Rates
Increase
P0=90
P1=80
Demand for bonds
When the Fed Wants to Reduce
Inflation
Use Contractionary Monetary Policy
Decrease the Money Supply
Increase the interest rate.
Sell Bonds
Increase d
Increase r
Decrease Investment and Consumption?
Decrease Aggregate Demand for
goods and services
Price = $100
i=10%
Get at maturity =
$110
Interest
10%
rate
Price you
Amount you
paid for
get at maturity Bond
100
110
= Price you paid for
100
Bond
Price = $100
i=10%
Get at maturity =
$110
Interest
rates drop to
8%
Amount at maturity - Bond Price
110
100
P?
10%
8% =
Bond Price
P?
100
10%
8%
=
Interest
rates drop to
8%
0.08
=
110
-
100
P?
P?
110
P + 0.08P = 110
1.08P = 110
P = 110/1.08
P?
P
P?
Bond Price
rises
= $101.85