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Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level 12 C H A P T E R – PART 2 Monetary Policy and Equilibrium GDP Monetary Policy Effectiveness of Monetary Policy Targeting the Federal Funds Rate CENTRAL BANK OF CANADA Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 1 Next Slide Copyright McGraw-Hill/Irwin, 2002 GOALS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 2 Next Slide …to assist the economy in achieving a full-employment, noninflationary level of total output Copyright McGraw-Hill/Irwin, 2002 CONSOLIDATED BALANCE SHEET OF THE FEDERAL RESERVE BANKS Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 3 Next Slide ASSETS • Securities • Loans to Commercial Banks LIABILITIES • Reserves of Commercial Banks • Treasury Deposits • Federal Reserve Notes Copyright McGraw-Hill/Irwin, 2002 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 4 Next Slide Open Market Operations Buying Securities From commercial banks... • Bank gives up securities • FED pays bank • Banks have increased reserves From individuals... • Individual gives up securities • Individual deposits check in bank • Banks have increased reserves Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level FEDERAL RESERVE PURCHASE OF BONDS Purchase of a $1000 bond from a bank... New reserves $800 Excess Reserves $200 Required reserves Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy $4000 Bank System Lending Key Terms Previous Slide End Show 12 - 5 $1000 Initial Deposit Next Slide Total Increase in Money Supply ($5000) Copyright McGraw-Hill/Irwin, 2002 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 6 Next Slide Open Market Operations The Reserve Ratio Raising the Reserve Ratio • Banks must hold more reserves • Banks decrease lending • Money supply decreases Lowering the Reserve Ratio • Banks may hold less reserves • Banks increase lending • Money supply increases Copyright McGraw-Hill/Irwin, 2002 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 7 Next Slide Open Market Operations The Reserve Ratio The Discount Rate Easy Money Policy • Buy Securities • Decrease Reserve Ratio • Lower Discount Rate Copyright McGraw-Hill/Irwin, 2002 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 8 Next Slide Open Market Operations The Reserve Ratio The Discount Rate Easy Money Policy Tight Money Policy • Sell Securities • Increase Reserve Ratio • Raise Discount Rate Copyright McGraw-Hill/Irwin, 2002 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 9 Next Slide Open Market Operations The Reserve Ratio The Discount Rate Discuss relative Easy Money Policy importance Tight Money Policy each control •of Sell Securities • Increase Reserve Ratio • Raise Discount Rate Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 10 Next Slide MONETARY POLICY, REAL GDP AND THE PRICE LEVEL Cause-Effect Chain • Money supply impacts interest rates • Interest rates affect investment • Investment is a component of AD • Equilibrium GDP is changed Copyright McGraw-Hill/Irwin, 2002 MONETARY POLICY AND EQUILIBRIUM GDP Sm1 S m2 Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Real rate of interest, i Goals of Monetary Policy Monetary Policy and Equilibrium GDP 10 10 8 8 6 6 Dm 0 Effectiveness of Monetary Policy Quantity of money demanded and supplied Targeting the Federal Funds Rate Key Terms Previous Slide End Show 12 - 11 Next Slide AS Price level Monetary Policy and the International Economy Investment Demand P2 P1 0 Amount of investment, i Money Supply Increases If the money supply increases Investment Increases to stimulate the economy... AD & GDP Increases Interest Rate Decreases AD1 AD2 Real domestic output, GDP Copyright McGraw-Hill/Irwin, 2002 with slight inflation MONETARY POLICY AND EQUILIBRIUM GDP Sm1 S S m2 m3 Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Real rate of interest, i Goals of Monetary Policy Monetary Policy and Equilibrium GDP 10 10 8 8 6 6 Dm 0 Effectiveness of Monetary Policy Quantity of money demanded and supplied Targeting the Federal Funds Rate Key Terms Previous Slide End Show 12 - 12 Next Slide AS Price level Monetary Policy and the International Economy Investment Demand P3 P2 P1 0 Amount of investment, i More Money Supply If theInterest moneyRates Lower supply increases More Investment again… AD1 AD2 AD3 Real domestic output, GDP Copyright McGraw-Hill/Irwin, 2002 Still higher AD & GDP with significant inflation Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy MONETARY POLICY, REAL GDP AND THE PRICE LEVEL Effects of an easy money policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Effects of a tight money policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 13 Next Slide Monetary policy & aggregate supply Copyright McGraw-Hill/Irwin, 2002 EFFECTIVENESS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 14 Next Slide Strengths of monetary policy • Speed and flexibility • Isolation from political pressure • Successes in the 1980s & 1990s Shortcomings and problems • Less control? • Changes in velocity • Cyclical asymmetry Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level TARGETING THE FEDERAL FUNDS RATE Generalized Interest Rate Changes Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 15 Next Slide Money Supply Impact The Federal Funds Rate The Prime Interest Rate Copyright McGraw-Hill/Irwin, 2002 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 16 Next Slide MONETARY POLICY AND THE INTERNATIONAL ECONOMY • Net export effect • Macro stability and the trade balance • The “Big Picture” Chapter Conclusions Copyright McGraw-Hill/Irwin, 2002 monetary policy open-market committee reserve ratio discount rate easy money policy tight money policy velocity of money cyclical asymmetry Federal funds rate prime interest rate Copyright McGraw-Hill/Irwin, 2002 BACK END Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Extending the Analysis of Aggregate Supply Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Next Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 12 - 18 Next Slide Copyright McGraw-Hill/Irwin, 2002
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