Download INVESTING

MONETARY POLICY
OPERATED BY THE FEDERAL
RESERVE
GOALS:
PROMOTE PRICE STABILITY
(LOW INFLATION)
PROMOTE FULL EMPLOYMENT
(LOW UNEMPLOYMENT RATE)
TOOLS USED BY THE FEDERAL RESERVE
CHANGING THE REQUIRED RESERVE
RATIO (% OF DEPOSITS, OR RESERVES)
KEPT IN THE VAULT
CHANGING THE INTEREST RATES THE
“FED” CONTROLS
CHANGING THE MONEY SUPPLY
TO FIGHT A RECESSION, THE FED WOULD:
LOWER THE REQUIRED RESERVE
RATIO – GIVES BANKS MORE
RESERVES TO LOAN
LOWER THE FED’S TWO INTEREST
RATES IT CONTROLS
* borrowing from the Fed
* interbank lending
BOTH MOVES DESIGNED TO
STIMULATE BORROWING AND
SPENDING
BUT THE FED’S BIGGEST TOOL IS MONEY CREATION
FED WILL PRINT MONEY IN HOPES
PEOPLE WILL SPEND IT – THEREBY
INCREASING SALES FOR BUSINESSES
AND MOTIVATING BUSINESSES TO
HIRE MORE WORKERS
FED’S RECENT MONETARY POLICY
M base
fed fd rt
2500
6
2000
5
1500
4
3%
$ bils.
1000
2
500
1
0
0
IF FED THINKS THE ECONOMY NEEDS TO
BE SLOWED – EXPANDING TOO FAST:
“TAKING AWAY THE PUNCH BOWL”
INCREASE THE REQUIRED RESERVE RATIO
INCREASE INTEREST RATES
REDUCE THE AMOUNT OF MONEY IN
CIRCULATION
RESULT – FEWER LOANS AND SPENDING
ISSUES WITH MONETARY POLICY
FED CAN MOVE QUICKLY IN
IMPLEMENTING ITS POLICIES
BUT POLICIES TAKE TIME TO
HAVE AN IMPACT – ANYWHERE
FROM 12 TO 18 MONTHS
REASON – WORKS THROUGH
THE LENDING PROCESS
ALSO, FED POLICIES CAN “BACKFIRE”
“EASY” MONEY POLICY CAN
LEAD TO HIGHER INFLATION
AND INVESTMENT “BUBBLES
* EASY MONEY IN EARLY 1970S
LEAD TO HIGH INFLATION OF
LATE 1970S
* EASY MONEY OF EARLY 2000s
LED TO HOUSING BUBBLE ?
ALSO, A “TIGHT” MONEY POLICY CAN:
RAISING INTEREST RATES AND
CUTTING THE MONEY SUPPLY CAN
LEAD TO A RECESSION
* VOLCKER AND RECESSION OF
EARLY 1980S
* GREEENSPAN/BERNANKE BEGAN
RAISING INTEREST RATES IN
LATE 2004 – CAUSED HOUSING
BUBBLE TO “POP”?
FED HAS SPARKED CONTROVERSY
SOME SAY “END THE FED”
* COMMON CURRENCY BACKED BY
GOLD
* MUCH HIGHER REQUIRED RESERVE
REQUIREMENTS
* PRIVATE INSURANCE FOR
DOPOSITS
BOTTOM LINE: MONETARY POLICY IS
VERY POWERFUL
BUT, FED HAS TO WORRY ABOUT
WINNING THE CURRENT BATTLE YET
LOSING THE NEXT
NOBEL PRIZE WINNING ECONOMIST
MILTION FRIEDMAN OFTEN SAID THE
FED’S BACK AND FORTH POLICIES
(EASY FOLLOWED BY TIGHT, ETC) LED
TO MORE VOLATILE BUSINESS CYCLES
ISSUES HAVE COME TO FOREFRONT WITH “TOO BIG TO FAIL”
“Moral Hazard” – if banks know will
be “bailed out”, will take more risk?
Possible solutions?
* let them fail – but brings down
entire economy?
* restrict lending and investments but hinders economic growth?
* restrict size of banks – but lose
some advantages; business goes
to foreign banks?