Transcript PP--Monetary Policy

Monetary Policy:
Regulating Money Supply
Review
Quiz
Trade Quiz
#1: What are the two conflicting responsibilities of
the Federal Reserve?
Maximizing GDP & Employment while at the
same time keeping inflation low
Review Quiz
#2: What are two ways the Fed has some
political independence when it comes to
making their decisions?
14-year term of office
Don’t rely on money from Congress to
keep running
Review Quiz
#e: How many members of the Fed Board
of Governors are there?
7
Review Quiz
#4: How many District Branches of the
Federal Reserve system are there?
12
Review
Quiz
Trade Quiz
#5: What is the “discount rate?”
The interest rate that the Federal Reserve
charges on direct loans to the 12 District
Banks
Review
Quiz
Trade Quiz
#6: Who is on the Federal Open
Market Committee (FOMC?
The 7 members of the Board of Governors
and 5 of the presidents of the District Banks
Review
Quiz
Trade Quiz
#7: What important decisions does the
FOMC make?
What the FFR should be and how much
money there should be in the economy?
Federal Reserve Structure
Discount Rate=Interest rate that the Fed
lends money directly to District Banks
(rarely used)
MeetsFederal
8 timesReserve
a year to
vote on Monetary
Federal Open
Board
of
Policy
Market Committee=
Governors
(7 members)
Ben Bernanke
Chairman
7 Governors
+ 5 District Bank
Presidents—meets 8 times
per year
Federal Funds Rate = Interest rate
that the 12 District banks charge
Each other on overnight loans
SF Fed Building—Market Street
12 District Federal
Reserve Banks
Boston
San Francisco
New York
Atlanta
Chicago
Dallas, etc.
Member Banks
All national banks
Some state banks
The Money Market
Supply of Money is fixed by the Fed
The Money Market
Interest
Rate
(FFR)
Fed “controls” money supply through
monetary policy
S-Money
Demand for money is downward sloping
D-Money
as interest rates ↓ more $ is demanded
Qty $
Modern-day economies are almost entirely
run on CREDIT—it’s all about borrowing
CONSTANTLY
2 Types of Monetary Policy
• LOOSE Monetary Policy
(increasing the money supply)
• TIGHT Monetary policy
(decreasing the money supply)
Two Tools of Monetary Policy
1.
Discount Rate Changes
•
Changing the interest rate at which District
Banks borrow directly from the Fed
Two Tools of Monetary Policy
2. Open Market Operations
–
Federal Reserve action to buy or sell Treasury bonds
--
This changes the money supply, which shifts
the Federal Funds Rate
*Demonstration
Loose (aka Expansionary) Monetary Policy
• First, the Fed lowers the discount rate (i.e. 3% to 2%)
• Next, the Fed uses Open Market Operations to increase money
supply
--the Fed Buys government bonds from anyone selling them
Interest
Rate (FFR)
Price
Level
MS1 MS2
Affects ADpeople borrow
& spend more
FFR1 --------2
FFR
-------------------
AS1
MD
Qty of $
AD2
AD1
Real
GDP
Important Fact: Time Lag
FYI: Both Fiscal Policy (6-12
months) and Monetary Policy
(12-24 months) have a time lag
Translation: they do not have
immediate effect
Tight (aka Contractionary)Monetary Policy
• First, the Fed raises the discount rate (i.e. 4.5% to 5.0%)
• Next, the Fed uses Open Market Operations to decrease
money supply
--the Fed Sells government bonds to willing investors
Interest
Rate (FFR)
MS2
Price
Level
MS1
AS1
Affects ADpeople
borrow &
spend less
2
FFR-------------
FFR1---------------
MD
Qty of $
AD1
AD2
Real
GDP
Economic Issue
Policy Type
(Moderately Loose,
Aggressively Loose,
Moderately Tight,
Aggressively Tight, or
Take No Action)
What action What would What change What action in
Open Market
would the the Fed want in the Money
Operations
Fed take
to happed to Supply would
be needed to
would be
regarding
the Federal
bring about
needed to
Discount
Funds Rate
the desired
bring about
Rate
(increase or change in FFR
the desired
(increase or
change in
(increase or
decrease)
Money
Supply
decrease)
decrease)
(Buy or Sell
Treasury Bills)
1. Inflation rises
to 10%
2. GDP growth is at
0.9%; the inflation rate
is 1.8%
3. GDP growth rate is
2.1% and the inflation
rate is 3.5%
4. Consumer
confidence is falling;
retail sales very weak;
unemployment at 8.1%
5. GDP growth is at
4.2%; inflation is at
3.6%
Decrease
Money
Supply
Aggressively
Tight
Increase
Discount Rate
Increase
FFR
Moderately
Loose
Decrease
Discount Rate
Decrease
FFR
Increase
Money
Supply
None
OR
Increase
Discount Rate
None
OR
Increase
FFR
None
OR
Decrease
Money
Supply
None
OR
Sell T-Bills
Decrease
Discount Rate
Decrease
FFR
Increase
Money
Supply
Buy T-Bills
Increase
FFR
Decrease
Money
Supply
None
OR
Moderately
Tight
Aggressively
Loose
Moderately
Tight
Increase
Discount Rate
Sell T-Bills
Buy T-Bills
Sell T-Bills
18
News Clips
http://video.msn.com/video.aspx?mkt=en-us&vid=2d392a8b-ac77-4e73-8999c31db8966b68
***(4:29) good clip when Fed was considered cutting FFR from 1.5%
http://video.msn.com/video.aspx?mkt=en-us&vid=5dc4a263-0085-4db0-aecb-81f39870a9
(roundtable on FFR increase to 4.75%) (7:40)
http://video.google.com/videosearch?q=federal%20funds%20rate
%20suze%20orman&rls=com.microsoft:*&oe=UTF-8&startIndex=&start
Page=1&um=1&ie=UTF-8&sa=N&hl=en&tab=wv#
(Suze Orman on FFR) (4:32)
http://www.asterpix.com/v/8654211/fed-cuts-interest-rates/
***(first 45 seconds of 2 minute clip)
Economic Issue
1. Inflation rises to
10%
2. GDP growth is at
4.2%; inflation is
at 3.6%
3. GDP growth is 2.1%
and the inflation rate
is 3.5%
4. Consumer confidence
is falling; retail sales very
weak; unemployment at
8.1%
5. GDP growth is at
0.9%; inflation rate is
1.8%
Policy Type
(Moderately Loose,
Aggressively Loose,
Moderately Tight,
Aggressively Tight, or
Take No Action)
Aggressive
Contractionary
Moderate
Contractionary
Take no action
OR
Mod. Contractionary
Aggressive
Expansionary
Moderate Expansionary
Action on
Open Market
Operations
(Buy or Sell
Treasury Bills
Effect on
Federal
Funds Rate
(increase or
decrease
Effect on
the Money
Supply
(increase or
decrease)
Sell T-Bills
Decrease
Money
Supply
Increases
FFR
Sell T-Bills
Decrease
Money
Supply
Increases
FFR
None
None
OR
OR
Sell T-bills Decrease MS
Buy T-Bills
Increase
Money
Supply
Buy T-Bills
Increase
Money
Supply
None
OR
FFR
Decreases
FFR
Decreases
FFR
Monetary POLICY
Monetary Policy will shift AD curve
Economy in recession
AS1
Price
Level
Loose monetary policy needed
AD1
Real
GDP
AD2
Buys Securities & lowers discount rate
Money becomes cheaper;
Interest rates go down
AD shifts right
Economic Situation:
GDP growth at +5.0%, Inflation rising, Unemployment 3%
Loose or Tight Monetary policy needed?
Solution:
Interest
Rate
Tight Monetary Policy
MS2 MS1
Price
Level
AS1
Affects AD
i2
AD1
---------
i1 ---------------
AD2
MD
End Result: Lower GDP & less inflation!
Qty of $
Real
GDP
Situation: GDP growth at -2.0%, Unemployment 9%
Loose or Tight Monetary policy needed?
Loose Monetary Policy
Interest
Rate
MS1 MS2
Price
Level
AS1
Affects AD
i1
---------
i2 --------------MD
Qty of $
AD1
Real
GDP
AD2
Loose Monetary Policy
LOWERS Discount Rate
1. Fed _________
2. Open-Market Operations
BUYS Securities
Fed _________
Interest
Rate
Price
Level
MS1 MS2
AS1
Affects AD
i1 ---------
AD2
i2 --------------MD
Qty of $
AD1
Real
GDP
Tight Monetary Policy
RAISES
1. Fed _________ Discount Rate
2. Open-Market Operations
SELLS Securities
Fed _________
Nominal
Interest
Rate
MS2
Price
Level
MS1
AS1
Affects AD
i2
--------AD1
i1 --------------MD
Qty of $
AD2
Real
GDP