Transcript Monetary Policy

Special Topics in Economics
Econ. 491
Chapter 4:
Understanding Economic Indicators
(Unemployment, Prices, Financial
&Monetary Data)
I. Employment
 Unemployment Rate:
- Measures the percentage of total labor force that is
unemployed.
- The unemployment rate lags changes in other labormarket data, since most businesses alter work
schedules before hiring or laying off employees.
- It measures the balance between demand and supply
in the labor market and is widely regarded as the most
important and timely measure of resource utilization.
- Can be defined as the failure to use all available
economic resources to produce desired goods and
services; the failure of the economy to fully employ its
labor force.
- Unemployment can be measured as;
Unemployment
Rate
= (unemployed / Labor Force) x 100
- How unemployment rate data affect the economy?
- Think of the relationship between this indicator and
the currency.
 Unemployment Insurance Claims:
- Measuring the number of individuals filing claims
for jobless insurance benefits and the number
receiving payments.
- Any change in these claims can be a useful signal of
shifting trends in the labor market ( Think of the links
between increase in claims and economic recession).
- Unemployment insurance claims have large effect ,
as families on unemployment insurance maintain
necessary spending more than saving. How!!
II. Prices & Construction
 Consumer Price Index (CPI):
- The index is also called a cost of living index.
- This index tracks the average price level of a basket
of goods and services that consumers regularly buy in
the country.
- The CPI represents major groups such as food &
beverages, housing, transportation, medical care,
recreation, education, other goods and services)
- The index is collected from consumer expenditure
surveys. Prices are indexed to 100 in a given year .
- Does the CPI include investment items (stocks,
bonds, real estate), and why?
- The CPI is the best measure of inflation. Explain!!
- Think of the link between the CPI and Economy.
 Producer Price Index (PPI):
- This index is a family of indexes that measure the
average selling prices received by the country
producers of goods and some services .
- It consists of a survey that covers individual
products ( around 8000 in USA) and product groups.
- PPI limits its value to be an inflation indicator.
Why!!
 Wholesale Price Index (WPI):
- This index measures the price of goods at a
wholesale stage ( goods traded between organizations
rather than goods bought by consumers).
- WPI is used as a measure of inflation in some
economies ( i.e India, Philippines), whereas PPI is
used to measure inflation in other countries ( i.e
USA).
- The purpose of the WPI is to monitor price
movements that reflect supply and demand in
industry, manufacturing and construction.
 Export and Import Price Index :
- These indexes ( Export price index and import price
index) are used to deflate the merchandise trade
figures, analyzing terms of trade, and exchange rate
and price elasticity of trade volumes.
- Markets tend to focus on movements in the price
index for imports. Why!!
-However, the export price index, in conjunction with
change rate changes, are useful in judging the relative
competitiveness of the country’s produced goods in
foreign markets. Why!!
III. Monetary and Financial Data
 Monetary Aggregates:
- The central bank tracks various measures of the
stock of money in circulation and related aggregates
of liquid assets.
- Currently most central banks focus on two such
measures :
1-M1;
Currency in circulation + Demand Deposits+ Travel Checks
2-M2;
M1 + Saving Deposits+ Time Deposits
- These aggregates especially M2 have high market
impact.
- Monetarist economic theory holds that changes in
the money supply should, over time, yield fairly
predictable changes in nominal economic activities or
output.
- According to this theory, accelerations or
decelerations in money stock growth influence real
economic activity in the short term but only inflation
in the long term.
 Monetary Base:
- The monetary base is meant to measure the supply of
“high powered money” in the economy that can be
leveraged by the banking system for future lending
activity.
- The monetary base consists of (1) total bank
reserves, (2) the currency portion of the money stock.
- Many monetarists believe that changes in growth of
the monetary base presage similar changes in the
monetary aggregate growth rates.
- A major problem with the monetary base as a
measure of the stance of monetary policy is that it is
comprised mostly of currency,
- Thus, fluctuations in currency can be sometimes be
related to changing domestic or international liquidity
preferences rather than developments regarding final
demand or lending. ( Explain !! )
 Tools of the Monetary Policy:


- Tools of the monetary policy are used to influence
the money supply at the economy.
- First tool is the Open market operations which
consists of buying and selling of government
securities (or bonds).
When the Central Bank sells securities (OMS),
commercial bank reserves are reduced (Money supply
decreases…Why? )
When the Central Bank buys securities (OMP) ,
commercial bank reserves are increased (Money
supply increases .. Why?)
- Second tool is the Reserve requirement Ratio
(RRR) which represents part of the deposits at each
commercial bank should be kept at the central bank.

When the Central Bank increases RRR, commercial
bank reserves are reduced (Money supply
decreases…Why?)

When the Central Bank decreases RRR, commercial
bank reserves are increased (Money supply
increases…Why?)
- Third tool is the Discount Rate(Rd) which
represents is the interest rate that the central bank
charges to commercial banks that borrow from the
central bank..

When the Central Bank increases Rd, commercial
bank reserves are reduced (Money supply
decreases…Why?)

When the Central Bank decreases Rd, commercial
bank reserves are increased (Money supply
increases… Why?)

Monetary Policy
The monetary policy is the use of monetary policy
tools to affect the Aggregate Demand (AD).

Expansionary monetary policy
To increase AD, central bank aims to increase Money
Supply using:
OMP, or lower RRR, or lower Rd

Restrictive(Contractionary)monetary policy
To increase AD, central bank aims to decrease Money
Supply using:
OMS, or rise RRR, or rise Rd
•LO
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