Download Eco 200 – Principles of Macroeconomics

Eco 200 – Principles of
Macroeconomics
Chapter 14: Monetary Policy
Federal Reserve System
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Debate over central bank – First and Second National Banks
Federal Reserve Act – 1913
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12 District Banks
Board of Governors – 7 members - 14 year “non-renewable” term
Chair of Board – 4-year term – does not coincide with President’s
term – “second most powerful person in the U.S.”
12 District Banks – 9 person board (6 elected by members banks in
the district, 3 appointed by Board of Governors)
Federal Open Market Committee – 12 members (Board of Governors
+ 5 District Bank Presidents selected on a rotating basis, but always
including President of NY Fed)
Fed autonomy
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Autonomous?
14-year terms
The President does not appoint a majority of
the board in a single term in office
No need for budget request from Congress
Autonomy created by act of Congress and
may be removed by an act of Congress.
Functions of the Fed
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Provides banking services and
supervision
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Supplies currency
Holds reserves
Clears checks
Makes loans to banks (discount loans)
Controls the money supply
Implementing monetary policy
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Policy goals: economic growth, low
unemployment, and price stability
Intermediate targets – objectives that
are used to help achieve policy goals
(examples: money supply or interest
rate targets)
Equation of Exchange
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MV = PY
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M = quantity of money
P = price index
Y = real GDP
V = # of times a typical dollar is used to purchase
GDP = PY / M
Quantity theory of money
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V is constant (and Y is constant in the long run)
Changes in M result in changes in proportionate
changes in nominal GDP (and only in the price
level in the long run)
Tools of monetary policy
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Reserve requirement
Discount rate (also affects the federal funds
rate)
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Discount rate – interest rate charged by Fed on
loans of reserves to banks
Federal funds rate = interest rate charged by
banks on loans of reserves to other banks
Open market operations – buying or selling
government bonds (most commonly used tool
of monetary policy)
Monetary policy
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To expand the money supply, the Fed
may:
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Lower the reserve requirement ratio
Lower the discount rate
Buy government securities
Foreign Exchange Market
intervention
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Buying or selling currencies to maintain
target exchange rate
Shown on board
Sterilization – open market operations
to offset the domestic money supply
effect of foreign exchange market
intervention
Money demand
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Reasons for holding money:
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Transactions demand
Precautionary demand
Speculative demand
Quantity of money demanded:
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Rises as nominal income rises (a higher price level
or higher real GDP results in an increase in
demand)
Declines as the interest rate rises
Money demand
Money demand and income
Money Supply
Equilibrium
Monetary transmission
mechanism: Keynesian model
Monetary transmission
mechanism (cont.)
Monetary transmission
mechanism (cont.)