Transcript L. Block Day March 26-27--PP-

Monetary Policy:
Regulating Money Supply
2 Types of Monetary Policy
• LOOSE Monetary Policy
(increasing the money supply)
• TIGHT Monetary policy
(decreasing the money supply)
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
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
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
7
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 those people who own 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
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
(Moderate Expansionary,
Aggressive Expansionary,
Moderate Contractionary,
Aggressive Contractionary,
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
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)
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