Transcript CHAPTER 14: Monetary Policy What Is Monetary Policy?

chapter
fourteen
Monetary Policy
Prepared by: Fernando & Yvonn Quijano
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
1 LEARNING OBJECTIVE
What Is Monetary Policy?
CHAPTER 14: Monetary Policy
Monetary policy The actions the Federal Reserve
takes to manage the money supply and interest rates to
pursue its economic objectives.
The Goals of Monetary Policy
The Fed has set four monetary policy goals that are intended to
promote a well-functioning economy:
1.
PRICE STABILITY
2.
HIGH EMPLOYMENT
3.
ECONOMIC GROWTH
4.
STABILITY OF FINANCIAL MARKETS AND
INSTITUTIONS
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
2 of 30
What Is Monetary Policy?
The Goals of Monetary Policy
CHAPTER 14: Monetary Policy
PRICE STABILITY
14 - 1
The Inflation Rate, 1952-2004
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
3 of 30
2 LEARNING OBJECTIVE
The Money Market and the Fed’s Choice of Targets
Monetary Policy Targets
CHAPTER 14: Monetary Policy
The Demand for Money
14 - 2
The Demand for Money
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
4 of 30
The Money Market and the Fed’s Choice of Targets
Shifts in the Money Demand Curve
14 - 3
CHAPTER 14: Monetary Policy
Shifts in the Money Demand Curve
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
5 of 30
The Money Market and the Fed’s Choice of Targets
CHAPTER 14: Monetary Policy
How the Fed Manages the Money Supply: A Quick
Review
Equilibrium in the Money Market
14 - 4
The Impact on the Interest
Rate When the Fed Increases
the Money Supply
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
6 of 30
The Money Market and the Fed’s Choice of Targets
Equilibrium in the Money Market
CHAPTER 14: Monetary Policy
14 - 5
The Impact on Interest Rates
When the Fed Decreases
the Money Supply
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
7 of 30
14 - 1
2 LEARNING OBJECTIVE
CHAPTER 14: Monetary Policy
The Relationship between Treasury Bill Prices and
Their Interest Rates
What is the price of a Treasury bill that pays $1,000 in one
year, if its interest rate is 4 percent? What is the price of the
Treasury bill if its interest rate is 5 percent?
 $1,000  P 

 x 100  4
P


© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
8 of 30
The Money Market and the Fed’s Choice of Targets
A Tale of Two Interest Rates
CHAPTER 14: Monetary Policy
Choosing a Monetary Policy Target
The Importance of the Federal Funds Rate
Federal funds rate The interest rate banks charge
each other for overnight loans.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
9 of 30
The Money Market and the Fed’s Choice of Targets
The Importance of the Federal Funds Rate
14 - 6
CHAPTER 14: Monetary Policy
Federal Funds Rate Targeting,
January 1995- July 2005
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
10 of 30
3 LEARNING OBJECTIVE
Monetary Policy and Economic Activity
CHAPTER 14: Monetary Policy
How Interest Rates Affect Aggregate Demand
Changes in interest rates will not affect government purchases,
but they will affect the other three components of aggregate
demand in the following ways:

Consumption

Investment

Net exports
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
11 of 30
Monetary Policy and Economic Activity
CHAPTER 14: Monetary Policy
The Effects of Monetary Policy on Real GDP and the
Price Level
Expansionary monetary policy The Federal
Reserve’s increasing the money supply and decreasing
interest rates in order to increase real GDP.
Can the Fed Eliminate Recessions?
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
12 of 30
Monetary Policy and Economic Activity
CHAPTER 14: Monetary Policy
Using Monetary Policy to Fight Inflation
Contractionary monetary policy The Fed’s
adjusting the money supply to increase interest rates
to reduce inflation.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
13 of 30
Monetary Policy and Economic Activity
CHAPTER 14: Monetary Policy
A Summary of How Monetary Policy Works
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
14 of 30
Monetary Policy and Economic Activity
Can the Fed Get the Timing Right?
CHAPTER 14: Monetary Policy
14 - 9
The Effect of a Poorly Timed
Monetary Policy on the Economy
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
15 of 30
A Closer Look at the Fed’s
Setting of Monetary Policy Targets
CHAPTER 14: Monetary Policy
The Taylor Rule
Taylor rule A rule developed by John Taylor that
links the Fed’s target for the federal funds rate to
economic variables.
Federal funds target rate = Current inflation rate +
Real equilibrium federal funds rate + (1/2) x
Inflation gap + (1/2) x Output gap
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
16 of 30
A Closer Look at the Fed’s
Setting of Monetary Policy Targets
CHAPTER 14: Monetary Policy
Should the Fed Target Inflation?
Inflation targeting Conducting monetary policy
so as to commit the central bank to achieving a
publicly announced level of inflation.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
17 of 30
5 LEARNING OBJECTIVE
Is the Independence of the
Federal Reserve a Good Idea?
The Case for Fed Independence
CHAPTER 14: Monetary Policy
The Case against Fed Independence
14 - 11
The More Independent the Central
Bank, the Lower the Inflation Rate
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
18 of 30
CHAPTER 14: Monetary Policy
Contractionary monetary policy
Expansionary monetary policy
Federal funds rate
Inflation targeting
Monetary policy
Taylor rule
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
19 of 30