Transcript CH24 Stabilizing the Economy:The Role of the

Chapter 24
Stabilizing the Economy:
The Role of the Federal
Reserve
Principle of Economics
National Chi Nan University
1
Learning Objectives
1.
2.
3.
4.
5.
Describe the structure and responsibilities of the Central
Bank (CB) System.央行系統
Analyze how changes in real interest rates affect
planned aggregate expenditures and short-run
equilibrium output (分析實質利率的改變如何影響PAE和短
期均衡產出).
Define what a monetary policy rule is.央行政策法則
 Relate this to the Fed's role in stabilization policy.
Show how the demand for money and the supply of
money determine equilibrium nominal interest rate.
Discuss how the CB uses control of the money supply
to influence nominal and real interest rates.
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Fed Watch

Analysts attempt to forecast Fed decisions about monetary
policy.
 Greenspan briefcase indicator (葛林斯潘公事包指數).
 Fed decisions have significant effects on global
financial market.

Monetary policy is a major stabilization tool.主要政策工具
 Quickly decided and implemented by Federal
Reserve’s Federal Open Market Committee (FOMC).
 More flexible and responsive than fiscal policy, which
can be changed only by legislative action by Congress.
 快速而有彈性
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Functions of CB (現代中央銀行的功能)

做為「政府的銀行」(government’s bank) :
 代理國庫: 現金、票據、證券的出納與保管
財產契約的管理
國內公外債、國庫券的發售與還本付息
 負責訂定利率與貨幣數量等貨幣政策的職權 (conduct
monetary policy)。

維持金融體系的安定 (Oversight and regulation of
financial markets)。
 Central to solving financial crises.
 金融監理
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
管理外匯準備 (外匯存底)，調節國際收支:
 中央銀行經由對外匯市場的干預，影響匯率及外匯準
備，進而影響進出口貿易量。

做為「銀行的銀行」(banker’s bank) :
 銀行的清算機構。
 最終借貸者
(lender of last resort)。
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
Lender of last resort (一國資金供應的最後供給者):
向銀行借錢
企業
向央行借錢
商業銀行
向IMF借錢
中央銀行
IMF
IMF (International Monetary Fund): 國際貨幣基金會
向IMF 借貸: 印尼、南韓(1997)、希臘(2010) 。
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我國中央銀行的施政目標

民國68年11月8日修正及公布的「中央銀行法」，中央銀
行的經營目標明訂為促進金融穩定、健全銀行業務、維護
對內及對外幣值的穩定，並在上列的目標範圍內，協助經
濟發展。
隨著經濟快速成長，中央銀行所肩負的首要任務由原先的
追求經濟高度成長，轉變為維持物價與金融穩定，並積極
參與金融體系的建制與改革。(Source: 中央銀行簡介)
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Taiwan Central Bank Organization
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The Federal Reserve Organization


Does not attempt to maximize profit (Fed is a government
agency).
12 Federal Reserve Bank districts.
 Research and forecasts relevant to their region.
Board of Governors (理事會) is the leadership of the Fed.
 Seven Governors are appointed by the President to
14-year terms.
 President selects one of the seven as Chairman for a
four-year term.
 FOMC is the committee that makes decisions concerning
monetary policy.

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The Twelve Federal Reserve Districts
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Chairman of the Fed
1. Charles S. Hamlin (August 10, 1914 — August 10, 1916)
2. William P. G. Harding (August 10, 1916 – August 9, 1922)
3. Daniel R. Crissinger (May 1, 1923 – September 15, 1927)
4. Roy A. Young (October 4, 1927 – August 31, 1930)
5. Eugene I. Meyer (September 16, 1930 – May 10, 1933)
6. Eugene R. Black (May 19, 1933 – August 15, 1934)
7. Marriner S. Eccles (November 15, 1934 – February 3, 1948)
8. Thomas B. McCabe (April 15, 1948 – April 2, 1951)
9. William McChesney Martin, Jr. (April 2, 1951 – Feb 1, 1970)
10. Arthur F. Burns (February 1, 1970 – January 31, 1978)
11. G. William Miller (March 8, 1978 – August 6, 1979)
12. Paul A. Volcker (August 6, 1979 – August 11, 1987)
13. Alan Greenspan (August 11, 1987 – January 31, 2006)
14. Ben S. Bernanke (February 1, 2006 – )
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CB’s Role and Banking Panics銀行擠兌

Banking panics (of 1930-1933) occurred when
customers believe one or more banks might be bankrupt.
 Depositors are afraid to keep deposits in a bank and
rush to withdraw funds.
 Banks have inadequate reserves to meet demand.
 Thus, banks close.

Fed prevents bank panics by
 Supervising and regulating banks.
 Loaning banks funds if needed.
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Bank Panics, 1930 – 1933

One-third of the banks closed.
 Increased the severity of the Great Depression
 Difficult for small businesses and consumers to get
credit.
 Money supply decreased. Why??
Reason 1: People are afraid to keep deposits in banks
 Withdrew money and held currency instead.
Money supply = Currency held by public
+
Bank reserves
Desired reserve–deposit ratio
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
With no federal deposit insurance (存款保險), people
held cash.
 They feared banks would close and they would lose
their deposits.
 Holding cash reduced banks' reserves.
 存款保險的額度

台灣：300萬新台幣；美國：10萬美元；日本：1千萬日幣
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Bank Panics, 1930 – 1933

Reason 2: Banks feared banking panic and the associated
withdrawals by the public, so they increased the reservedeposit ratio.
 further decreased the money supply.
Date
Currency
Held by
Public ($B)
Reserve –
Deposit
Ratio
Bank
Reserves
($B)
Money
Supply
($B)
12 / 1929
12 / 1930
3.85
3.79
0.075
0.082
3.15
3.31
45.9
44.1
12 / 1931
4.59
0.092
3.11
37.3
12 / 1932
12 / 1933
4.82
4.85
0.109
0.133
3.18
3.45
34.0
30.8
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Deposit Insurance

With no federal deposit insurance (存款保險), people held
cash.
 Because they feared banks would close and they
would lose their deposits.
 Holding cash reduced banks' reserves.

Congress created deposit insurance in 1934.
 Deposit
insurance is a system under which government
guarantees that depositors will not lose any money
even if their bank goes bankrupt.
 Deposits of less than $100,000 will be repaid even if
the bank is bankrupt.
 Decreases incentive to withdraw funds on rumors.
 臺灣: 每一存款人在同一家機構存款本金最高保額為新台
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幣300萬元
The Fed and the Economy
Eliminate output gaps by changing the
money supply
Changes in money supply cause
changes in nominal interest rate
Interest rates affect planned aggregate
expenditures, PAE
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Targeting Interest Rates: Real or Nominal
實質利率與名目利率



Fed controls the nominal interest rates, I, through
the control of money supply.
Investment and saving decisions are based on the
real interest rate, r
 Fed has some control over the real interest
rate
r = i - 
where  is the rate of inflation
Since inflation changes relatively slowly.
 Changes in nominal rates become changes in
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real rates.
Planned Spending and Real Interest Rate

Planned Aggregate Expenditures have components that
are affected by the real interest rate.
 Savings by households:
 More saving at higher real interest rates.
 Higher saving means less consumption.
 Investments by firms:
 Higher interest rates mean less investment.

Both consumption and planned investment decrease
when the interest rate increases.消費和投資是實質利率
的負向函數
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Interest in the Keynesian Model
– An Example



Components of aggregate spending are:
C = 640 + 0.8 (Y – T) – 400 r
IP = 250 – 600 r
G = 300
NX = 20
T = 250
If r increases from 0.04 to 0.05 (that is, from 4% to 5%)
 Consumption decreases by 400 (0.01) = 4
 Planned investment decreases by 600 (0.01) = 6
A one percentage point increase in r reduces planned
spending by 10 – before the multiplier is considered.
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Planned Aggregate Expenditures

To find the relationship between PAE and output:
PAE = C + IP + G + NX
PAE = 640 + 0.8 (Y – 250) – 400 r + 250 – 600 r
+ 300 + 20
= 1,010 – 1,000 r + 0.8 Y

In this example, planned aggregate expenditure depends
on both the real interest rate and the level of output.
 Equilibrium output can only be found once we know the
value of r.
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Planned Aggregate Expenditures
PAE = 1,010 – 1,000 r + 0.8 Y




If the real interest rate is 5%, or 0.05
Planned aggregate expenditures becomes
PAE = 1,010 – 1,000 (0.05) + 0.8 Y
= 960 + 0.8 Y
Short-run equilibrium output is PAE = Y
Y = 960 + 0.8 Y
0.2 Y = 960
Y = $4,800
The graphical solution is the same as before.
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Monetary Policy
Recessionary Gap
r
C, IP 
PAE 
Y  via the
multiplier
PAE 
Y  via the
multiplier
Expansionary Gap
r
C,
IP
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Monetary Policy for a Recessionary Gap
PAE = 1,010 – 1,000 r + 0.8 Y



Settings: The real interest rate, r, is 5%
 Short-run equilibrium output is $4,800
 Potential output is $5,000
 Let recessionary gap to be $200
 Multiplier is 5
Fed can lower the real interest rate to increase PAE.
 The change in spending required is 200 / 5 = 40
1,000 x ∆ r = 40
∆ r = 40 / 1,000 = 0.04 (4 percentage points)
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The Fed should decrease the real interest rate to 1%.
Planned aggregate expenditure (PAE)
The Fed Fights a Recession
Y = PAE
Expenditure line (r = 1%)
Expenditure line (r = 5%)
F
E
4,800 5,000
Y*
A reduction in r shifts the
expenditure line upward
and closes the recessionary
gap
Output (Y)
25/59
Federal Funds Rate

The federal funds rate (聯邦資金利率 or 隔夜拆款利率)
is the interest rate that banks charge each other for
overnight loans.
 Changes in the federal funds rate indicate changes
for Fed’s monetary policy.
 請問隔夜拆款利率作為政策目標的好處與壞處
 宏觀調控

(fine tune) 的操作意義
In late 2000, the fed funds rate was 6.5%
 January, 2001, the Fed cut the rate to 6.0%
 July, 2001, the rate was less than 4%
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The Fed Response to 9/11

After the 9/11 attacks
 The Fed temporarily lowered the federal funds rate
to 1.25%.

In the aftermath, the Fed concerned that consumers,
nervous about the future, would decrease spending.
 Fed continued to cut the federal funds rate until 1.0%
in June 2003 to stimulate the spending.

Combination of tax cuts and monetary policy helped
keep the 2001 recession shallow and short.
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Fed Fights Inflation央行對抗通貨膨脹

Expansionary gap can lead to inflation.
 If gap persists, prices will increase.

The Fed attempts to close expansionary gaps.
 Raise interest rates.
 Decrease consumption and planned
investment.
 Decrease planned aggregate expenditures.
 Decrease equilibrium output.
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Monetary Policy for an Expansionary Gap
PAE = 1,010 – 1,000 r + 0.8 Y



The real interest rate, r, is 5%
 Short-run equilibrium output is $4,800
 Let the potential output to be $4,600
 And let expansionary gap to be $200
 Multiplier is 5
Fed can raise the real interest rate to decrease PAE.
 The change in spending required is 200 / 5 = 40
1,000 x ∆ r = 40
∆ r = 40 / 1,000 = 0.04
The Fed should increase the real interest rate to 9% 29/59
Planned aggregate expenditure (PAE)
The Fed Fights Inflation
Y = PAE
Expenditure line (r = 5%)
Expenditure line (r = 9%)
E
G
4,600 4,800
Y*
An increase in r shifts the
expenditure line down and
closes the expansionary gap
Output (Y)
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Interest Rates Increased in 2004 and 2005
in the US

The recovery: real GDP growth was nearly 6% in the 2nd
half, 2003.
 Growth was 4.4% in 2004.
 Unemployment was 5.6% in June 2004.

Inflation increased in 2004, mainly due to oil prices.
 Fed began tightening monetary policy in June, 2004
(from 1% to 1.25%).
 Continued gradually raising the fed funds rate in order
to prevent the emergency of expansionary gap.
(持續漸進地提高聯邦資金利率是為了預防膨脹缺口發
生。)膨脹缺口時，物價也膨脹，2011年年中的情況 31/59
The Federal Funds Rate, 1970-2008
911
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Inflation and the Stock Market

News of inflation would influence stock market.

Good news about inflation (low inflation) causes stock
prices to increase.

Bad news about inflation (high inflation) causes stock prices
to decrease. Why?
 Investors anticipate the Fed will increase interest rates.
 投資大眾理性預期政府的作為；rational expectation
 Reduce planned spending and cold down the economy.
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Inflation and the Stock Market


The above contractionary policy affect stock price in two ways:
緊縮性政策不利於股票市場
 First, it slows down economic activity, lowering firms' sales and
perhaps profits.
 Lower profits mean lower dividends, which means lower
stock prices.
Second, an increase in interest rates reduces the
value of stocks (提高利率會使股票價值降低).


Bonds will become more attractive to investors, then the
demand for stocks decreases, and hence the stock
prices decreases.
 (投資者會對債券較感興趣，因此市場對股票的需求下
降，導致股價下降。)

還記得債券價格和利率呈反向關係？
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Should Fed Respond to Change in Stock Prices?

In the 1990s (Alan Greenspan period)
 S&P 500 increased 233% (from value of 457 to 1527)
between 1995 and 2000.美國空前榮景
 The US enjoyed a record-long business cycle
expansion.

After 2000, possible stock speculation (股市投機) led to
sharp decreases in stock prices.
 Critics argued: if the Fed had acted sooner, the run-up
would have been curtailed and the crash moderated.
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US Stock Prices, 1960 - 2004
1995
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Should Fed Respond to Change in Stock Prices?

Greenspan's response in 2002 is:
(1) It is very difficult to identify when asset market exists
bubble, and when the asset prices is inappropriately
high.
(2) Monetary policy is NOT a good tool for addressing
“bubbles” in stock markets (貨幣政策並非解決股市泡
沫的好工具). Then what is a good tool? No answer!
Since lowering stock prices by raising the federal
funds rate may lead to a recession and high
unemployment, which are the ones the Fed try to
avoid.
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Monetary Policy Rule
(The Fed Respond to A Change in Inflation)
Expansionary Gap
Recessionary Gap


r
r
Planned C and I 
Planned C and I 
PAE 
PAE 
Y
Y
38/59
Monetary Policy Rule (MPR)
央行心中應有一個法則，百姓會揣摩




The monetary policy rule (貨幣政策法則): the action a
central bank takes in response to changes in the economy.
 The Fed raises or lowers interest rate to respond to
changes in inflation rate.
Target inflation rate, *, is the Fed‘s long-term goal for
inflation.目標區
Target real interest rate, r*,
MPR
is the Fed's long-term goal
A
r*
for the real interest rate.
If  > *, then r > r*
If  < *, then r < r*
Real interest rate set by Fed
(r)

*
Inflation ()
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Monetary Policy Rule Example

The Fed's target interest rate is 4% and its target inflation
is 2%.
Actual Inflation, 

Actual Real Interest Rate
Set by the Fed, r
0.00 (0%)
0.02 (2%)
0.01
0.03
0.02
0.04
0.03
0.05
0.04
0.06
If the inflation rate reaches 3%, the Fed sets the interest
rates at 5%.
40/59



The up-ward slope of MPR
captures the Fed reacts to the
increase in inflation by raising
the real interest rate.
The slope of the MPR shows
how aggressively the Fed will
pursue inflation targets.
If MPR is quite flat, the Fed
changes the real interest rate
rather modestly in response to
a change in inflation.
Real interest rate set by Fed,
r
Graph of Fed's MPR
MPR
0.06
0.05
0.04
0.03
0.02
0.01 0.02 0.03 0.04
Inflation 
 若MPR平緩，表示 Fed 對於穩定通貨膨脹並不積極
MPR的斜律反映央行對於通貨膨脹的態度
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CB and Interest Rates

Controlling the money supply is the primary task of the
CB (控制貨幣供給是央行的主要任務).
 目的在於控制貨幣的價格，亦即利率

Money supply and money demand determine the interest
rate (federal funds rate).
 Fed
manipulates money supply to control the
nominal interest rate.
 The
nominal interest rate can be regarded as the
“price” of holding money (or, its opportunity cost).
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Demand for Money

Money is a way of holding wealth.
 The
demand for money is the amount of wealth an
individual chooses to hold in money.

Demand for money is sometimes called an individual‘s
liquidity preference (流動性偏好).
Ex: Larry holds $1000 in cash, $2000 in a checking
account, $2000 in government bonds, and $5000 in
rare stamps.  His demand for money is $3000.
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Demand for Money

How much money should one hold?
The Cost – Benefit Principle indicates people increase
their money holding if the marginal benefit of holding
money exceeds the marginal cost.

Money‘s benefit is the ability to make transactions.效益
 Demand for money increases with income.
(High-income individual  needs more money for more
transactions.)
 Technologies such as online banking and ATMs have
reduced the demand for money.
 M1 has decreased from 28% of GDP in 1960 to 12%
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in 2004.
Demand for Money

The cost of holding money is the interest foregone.成本
 Most
forms of money (cash or checking account) pay
little or no interest.
 In contrast, alternative assets such as stocks or
bonds have a positive nominal interest rate.

The higher the nominal interest rate on other assets (the
higher opportunity cost of holding money), the smaller
the quantity of money demanded.
(名目利率越高 (持有貨幣的機會成本越高)  對貨幣的需求
越少。)
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Factors that Affect Demand for Money

Demand for money depends on:影響貨幣需求三個因素
 Nominal interest rate (i)名目利率
 The higher the interest rate, the lower the quantity
of money demanded.
 Real income or output (Y)所得
 The higher the level of income, the greater the
quantity of money demanded.
(When booms, people do more shopping.)
 The price level (P)價格水準
 The higher the price level, the greater the quantity
of money demanded to make transactions.
46/59
The Money Demand Curve
貨幣供需模型：價量關係的模型

Interaction of the aggregate demand for money
(determined by the public) and the aggregate supply of
money (determined by the central bank) determines the
nominal interest rate.
The money demand curve shows the relationship between
the aggregate quantity of
money demanded, M, and
the nominal interest rate, i.
 An increase in the nominal
interest rate increases the
MD
opportunity cost of
holding money.
Money (M)
 Negative slope.
47/59
Nominal interest rate (i)

The Money Demand Curve

Changes in factors other than the nominal interest rate cause
a shift in the money demand curve.
An increase in demand for money can result from:
 An increase in output (Y).
 Higher price levels (P).
 Technological advances.
 Financial advances.
(ATM shifts the money
demand to the left，how
about plastic money?)
 Foreign

demand for
Nominal interest rate (i)

MD'
MD
Money (M)
dollars.
An increase in demand shift the money demand to the 48/59
right.
Supply of Money



CB primarily controls the supply of money with openmarket operations (OMO; 公開市場操作).
 An open-market purchase of bonds by CB increases
the money supply.
 An open-market sale of
bonds by CB decreases
MS
the money supply.
Supply of money is vertical.
E
i
貨幣供給垂直的經濟意義？
MD
Equilibrium is at E, the
equilibrium nominal interest
Money (M)
M
rate is i.
49/59
Nominal interest rate (i)

CB Controls the Nominal Interest Rate
The tool the Central Bank use is the supply of money.

Initial equilibrium at E.
 CB increases the money
supply to MS'.
 New equilibrium at F.
 Interest rated decrease to i'
to convince the market
to hold the new, larger
amount of money.
Nominal interest rate (i)

MS
MS'
E
i
i'
F
MD
M
M'
Money (M)
50/59
Fed Controls the Nominal Interest Rate
從貨幣市場的供需來看利率變動即可
To Decrease the Money Supply
Fed sells
bonds to
the public
Supply of
bonds
increases
Price of
bonds
decrease
Interest
rate
increases
To Increase the Money Supply
Fed buys
bonds
from the
public
Demand
for bonds
increases
Price of
bonds
increase
Interest rate
decreases
51/59
The Fed Targets the Interest Rate

The Fed cannot set the interest rate and the money
supply independently.

Fed policy is announced in terms of interest rates
because: 央行以利率作為政策標的
 Public is not familiar with the size of the money supply.
 Interest rate changes affect planned spending and
the level of economic activity.
 Interest rates are easier to monitor than the money
supply.
52/59
Additional Controls over the Money Supply
央行管制貨幣供給的方法

Open market operations (OMO) are the main tool of
money supply.

Other tools:
 Rediscount Rate (重貼現率政策)
 Required Reserve-deposit Ratio (法定存款準備率政策)
 Foreign Exchange Operations (外匯操作)
 Selective Credit Control (選擇性信用管制)
 Moral Suasion / Jaw Boning (道德勸說 / 下巴骨政策)
53/59
Rediscount Rate

Fed offers lending facility to banks, called discount
window lending. (貼現窗口融資; 係指一般銀行缺少資金
時，以其對顧客貼現而持有的商業票據，請求央行給予
『再貼現』，以取得資金。)
 If
a bank needs reserves, it can borrow from the Fed
at the (re-)discount rate
 The (re-)discount rate is the rate the Fed charges
banks to borrow reserves.

Lending increases reserves and ultimately increases the
money supply (銀行向央行借越多準備金，代表貨幣供給
增加).
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
Changes in the discount rate signal tightening or
loosening of the money supply.
 可鼓勵一般銀行向其融通資金(鼓
勵銀行向央行重貼現)  貨幣供給增加。
 當央行降低貼現率
 一般銀行向其融通資金的需求減
少  貨幣供給減少。
 當央行提高貼現率
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Required Reserve-deposit Ratio



The reserve requirement (法定存款準備) is the
minimum percentage of bank deposits that must be
held in reserves.
The Fed could increase the money supply by
decreasing the reserve requirement.
 Banks would have excess reserves (超額準備) to
loan.
當央行降低法定存款準備率  銀行可貸放之資金增加
 貨幣供給增加。
當央行提高法定存款準備率  銀行可貸放之資金減少
 貨幣供給減少。
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Foreign Exchange Operations

當央行買進外匯  釋出貨幣  貨幣供給增加。
當央行賣出外匯  收回貨幣  貨幣供給減少。
 但因外匯買賣會影響匯率水準，故央行採此政策時必
須謹慎。
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Selective Credit Control 選擇性信用管制
2011年的房屋貸款管制是一例

Selective Credit Control:
例如: 股市過熱  降低融資比例以抑制過多市場資金。
股市蕭條  提高融資比例以鼓勵市場資金投入。

Moral Suasion / Jaw Boning:
中央銀行對一般銀行口頭勸說 (而不採實質行動) 支持
貨幣政策，配合採取增加或減少貨幣供給的做法。
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Stabilizing the Economy: The Role of the Fed
Stock
Market
Supply of
Money
Money
Market
Demand
for Money
The Fed
Interest Rates:
Real, Nominal,
Fed Funds
Stabilization
Policy
Monetary Policy
Response Function
Keynesian
Model
Monetary
Policy
Open Market
Operations
Discount Rate
Reserve
Requirement
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