Transcript Modern macroeconomics: monetary policy

1. Created in 1913
2. Responsible for:
a. overseeing the money supply
b. coordinating commercial bank
operations
c. regulating depository institutions
• The Board of
Governors is at the
center of the banking
system in the U.S.
• The seven members
of the Board of
Governors also serve
on the Federal Open
Market Committee
• The FOMC is a 12member board that
establishes Fed policy
regarding the buying
and selling of
government securities.
Federal Reserve
Board of Governors
7 members appointed by the president,
with the consent of the U.S. Senate
Open Market
Committee
Board of Governors &
5 Federal Reserve Bank
Presidents (alternating
terms, New York Bank
always represented).
12 Federal Reserve
District Banks
(25 branches)
Commercial Banks
Savings & Loans
Credit Unions
Mutual Savings Banks
The Public:
Households & businesses
1. Board of Governors –
7 members appointed by President
- 14 yr terms at 2 yr intervals for continuity & independence
-not more than one from each district
http://www.federalreserve.gov/
• Each district bank monitors the commercial banks in their
region and assists them with the clearing of checks.
• The Board of Governors of the Federal Reserve System is
located in Washington D.C.
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1 Boston
2 New York City, Buffalo
3 Philadelphia
4 Cleveland, Pittsburgh, Cincinnati
5 Richmond, Baltimore, Charlotte
6 Atlanta, Nashville, Birmingham, Miami,
Jacksonville, New Orleans
7 Chicago, Detroit
8 St. Louis, Louisville, Memphis, Little Rock
9 Minneapolis, Helena
10 KC, Denver, Omaha, Oklahoma City
11 Dallas, San Antonio, El Paso
12 SF, Salt Lake City, LA, Port., Seattle, Honolulu
2. Federal Open Market Committee
-12 members = 7 Governors (for majority) plus
5 Pres or VP from
1 NY
2 Bost, Phila, or Richmond,
3 Atl, Dallas, or StL
4 Minn, KC, or SF, LA
5 Clev, or Chicago
set policy on buying & selling bonds on open mkt
3. Federal Advisory Council outsiders
12 members - 1 each selected by Board of
each Region
Make sure they are following the rules
Makes clearing check easier
Replace money or increase or decrease money in circulation
Moves checks from region to region
Borrows, writes checks, takes deposits
1. Price stability
2. High employment
3. Stability of financial markets
and institutions
4. Economic growth
1. Monetary Policy Tools:
a. The Reserve Requirement
-reducing it encourages loans and
increases the money supply
-increasing it discourages loans
and decreases the money supply
Type of Deposit
Current Requirement
Checkable Deposits
$0 - $14.5 million
$14.5 - $130.6 million
Over 130.6 million
savings
0 %
3
Limits
3%
3
10
8-14
0
0-9
b. The Discount Rate
3 rates
1. Discount Rate
2. Federal Funds Rate
3. Prime Rate
federal reserve to
member banks
bank to bank
banks to best
customers
b. The Discount Rate
Raising Discount Rate
discourages bank borrowing
decreases money supply
Lowering Discount Rate
encourages bank borrowing
increases money supply
c. Open Market Operations
Buying and Selling Securities (Bonds)
-selling bonds puts bonds out and
take money out of circulation
What effect will this have on the economy??
-buying bonds puts money back in
circulation and takes bonds in
What effect will this have on the economy??
Fed Buys
Fed Sells
Changing the Interest Rate
• The original equilibrium occurs at E0.
• Expansionary monetary policy shifts supply to the right.
•
reduces the interest rate from 8% to 6%.
• Contractionary monetary policy shifts supply to the left.
•
raises the interest rate from 8% to 10%.
a. The Reserve Requirement
Increase or decrease?
b. The Discount Rate
Raise or Lower?
c. Open Market Operations
Buy or Sell?
a. The Reserve Requirement
Increase or decrease?
b. The Discount Rate
Raise or Lower?
c. Open Market Operations
Buy or Sell?
Fed’s Past Policies
Episode 1
1979 and 1980, high inflation (over 10%),
the Fed raised interest rates 5.5% in 1977 to 16.4% in 1981.
By 1983, inflation was down to 3.2%,
(may have caused back-to-back recessions in 1980 and in 1981–1982)
Episode 2
In early 1980s, the Fed felt inflation was declining,
Fed reduced the federal funds rate from 16.4% in 1981 to 6.8% in 1986.
Episode 3
From 1986 to 1989, inflation rose from 2% to 5%.
the Fed raised the federal funds rates from 6.6% to 9.2%.
Inflation fell from above 5% in 1990 to under 3% in 1992
(but it helped to cause the recession of 1990–1991, and the unemployment
rate rose from 5.3% in 1989 to 7.5% by 1992.)
Episode 4
In the early 1990s, the Fed reduced interest rates 8.1% 3.5%.
The unemployment rate declined from 7.5% in 1992 to less than 5% by
1997.
Fed’s Past Policies
Episodes 5 and 6
With a risk of inflation the federal funds rate was raised from 3% to 5.8%
from 1993 to 1995.
No Inflation.
In 1999 and 2000, the Fed was concerned that inflation seemed to be
creeping up so it raised the federal funds rate from 4.6% in 12/98 to 6.5%
in 6/00.
By early 2001, inflation was declining again, but a recession occurred in
2001.
Between 2000 and 2002, the unemployment rate rose from 4.0% to 5.8%.
Episodes 7 and 8
the Fed slashed the federal funds rate from 6.2% in 2000 to 1.7% in 2002,
and to 1% in 2003.
In 2004, the unemployment rate declined and the Federal Reserve
began to raise the federal funds rate until it reached 5% by 2007.
Episode 9
Great Recession in 2008, the Fed slashed interest rates 2% to nearly 0%.
the economy was still deep in recession
Consumption. Lower interest rates lower the cost
of durable goods and reduce the return to saving,
leading households to save less and spend more.
Investment. Lower interest rates increase the
demand for stocks and make it less expensive for
firms and households to borrow, thereby increasing
investment.
Net exports. If interest rates in the United
States decline relative to interest rates in other
countries, the value of the dollar will fall and net
exports will rise.
Price
Level
LRAS
SRAS1
P2
P1
E2
e1
AD1
Y1 YF
AD2
Goods & Services
(real GDP)
• If the increase in AD is when the economy is
below capacity, the policy will help direct the
economy toward long-run full-employment
equilibrium YF.
Price
Level
LRAS
SRAS1
P2
P1
e2
E1
AD2
AD1
YF Y2
Goods & Services
(real GDP)
If the increase is at full-employment YF, they will
lead to excess demand, higher product prices,
and temporarily higher output Y2.
Price
Level
LRAS
SRAS2
SRAS1
P3
E3
P2
P1
e2
E1
AD2
AD1
Y F Y2
Goods & Services
(real GDP)
In the long-run, the strong demand pushes up
resource prices, shifting short run aggregate
supply (from SRAS1 to SRAS2).
The price level rises (from P2 to P3) and output falls
back to YF from its temporary high,Y2.
Too Low for Zero: The Fed Tries
“Quantitative Easing” and “Operation
Twist”
Quantitative easing - purchasing
securities—including certain mortgagebacked securities—beyond the short-term
Treasury securities that are usually
involved in open market operations. (Nov.
2008 and June 2011)
The economic recovery remained weak
Operation Twist - the Fed announced it
would purchase $400 billion in long-term
Treasury securities while it would sell an
equal amount of shorter-term Treasury
securities. (Sept 2011)
Both tried to reduce interest rates on
long-term Treasury securities, which
typically move closely with those on home
mortgage loans, in order to increase
aggregate demand.
The Federal Reserve can provide
reserves for banks to loan.
They can’t make them loan them
out.
Becoming unpredictable.
M * V = P *Y
M
one
My Velocity
V
Output
P
rice
P
Y
- the amount of money in circulation
- the number of times each $ is spent in a
year (considered to be stable)
- the level of prices
- the actual output of goods and services
M * V = P *Y
Money
• P
Velocity
*Y =
Y =output
Price
Total Sales (GDP)
• If V and P are constant, then an increase in
M will lead to a proportional increase in Y
GDP increases.
• but if V and Y are constant (at full
employment), then an increase in M will lead
to a proportional increase in P =Inflation.
Which to target?
1.It would draw the public’s attention to the
fact that the Fed can affect inflation but
not real GDP in the long run.,
2.
The Fed would make it easier for
households and firms to form accurate
expectations of future inflation, improving
their planning and the efficiency of the
economy.
3.
It get would help institutionalize good
U.S. monetary policy that is subject to
fewer abrupt changes as members join and
leave the FOMC.
4.
It would promote accountability for the
Fed by providing a yardstick against which
Congress and the public could measure the
Fed’s performance.
1.A numeric target reduces the flexibility of
monetary policy to address other policy
goals.
2.It assumes that the Fed can accurately
forecast future inflation rates, which is not
always the case.
3.Holding the Fed accountable only for an
inflation goal may make it less likely that
the Fed will achieve other important policy
goals.