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Transcript
chapter fourteen Monetary Policy Prepared by: Fernando & Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 1 LEARNING OBJECTIVE What Is Monetary Policy? CHAPTER 14: Monetary Policy Monetary policy The actions the Federal Reserve takes to manage the money supply and interest rates to pursue its economic objectives. The Goals of Monetary Policy The Fed has set four monetary policy goals that are intended to promote a well-functioning economy: 1. PRICE STABILITY 2. HIGH EMPLOYMENT 3. ECONOMIC GROWTH 4. STABILITY OF FINANCIAL MARKETS AND INSTITUTIONS © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 2 of 30 What Is Monetary Policy? The Goals of Monetary Policy CHAPTER 14: Monetary Policy PRICE STABILITY 14 - 1 The Inflation Rate, 1952-2004 © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 3 of 30 2 LEARNING OBJECTIVE The Money Market and the Fed’s Choice of Targets Monetary Policy Targets CHAPTER 14: Monetary Policy The Demand for Money 14 - 2 The Demand for Money © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 4 of 30 The Money Market and the Fed’s Choice of Targets Shifts in the Money Demand Curve 14 - 3 CHAPTER 14: Monetary Policy Shifts in the Money Demand Curve © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 5 of 30 The Money Market and the Fed’s Choice of Targets CHAPTER 14: Monetary Policy How the Fed Manages the Money Supply: A Quick Review Equilibrium in the Money Market 14 - 4 The Impact on the Interest Rate When the Fed Increases the Money Supply © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 6 of 30 The Money Market and the Fed’s Choice of Targets Equilibrium in the Money Market CHAPTER 14: Monetary Policy 14 - 5 The Impact on Interest Rates When the Fed Decreases the Money Supply © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 7 of 30 14 - 1 2 LEARNING OBJECTIVE CHAPTER 14: Monetary Policy The Relationship between Treasury Bill Prices and Their Interest Rates What is the price of a Treasury bill that pays $1,000 in one year, if its interest rate is 4 percent? What is the price of the Treasury bill if its interest rate is 5 percent? $1,000 P x 100 4 P © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 8 of 30 The Money Market and the Fed’s Choice of Targets A Tale of Two Interest Rates CHAPTER 14: Monetary Policy Choosing a Monetary Policy Target The Importance of the Federal Funds Rate Federal funds rate The interest rate banks charge each other for overnight loans. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 9 of 30 The Money Market and the Fed’s Choice of Targets The Importance of the Federal Funds Rate 14 - 6 CHAPTER 14: Monetary Policy Federal Funds Rate Targeting, January 1995- July 2005 © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 10 of 30 3 LEARNING OBJECTIVE Monetary Policy and Economic Activity CHAPTER 14: Monetary Policy How Interest Rates Affect Aggregate Demand Changes in interest rates will not affect government purchases, but they will affect the other three components of aggregate demand in the following ways: Consumption Investment Net exports © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 11 of 30 Monetary Policy and Economic Activity CHAPTER 14: Monetary Policy The Effects of Monetary Policy on Real GDP and the Price Level Expansionary monetary policy The Federal Reserve’s increasing the money supply and decreasing interest rates in order to increase real GDP. Can the Fed Eliminate Recessions? © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 12 of 30 Monetary Policy and Economic Activity CHAPTER 14: Monetary Policy Using Monetary Policy to Fight Inflation Contractionary monetary policy The Fed’s adjusting the money supply to increase interest rates to reduce inflation. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 13 of 30 Monetary Policy and Economic Activity CHAPTER 14: Monetary Policy A Summary of How Monetary Policy Works © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 14 of 30 Monetary Policy and Economic Activity Can the Fed Get the Timing Right? CHAPTER 14: Monetary Policy 14 - 9 The Effect of a Poorly Timed Monetary Policy on the Economy © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 15 of 30 A Closer Look at the Fed’s Setting of Monetary Policy Targets CHAPTER 14: Monetary Policy The Taylor Rule Taylor rule A rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables. Federal funds target rate = Current inflation rate + Real equilibrium federal funds rate + (1/2) x Inflation gap + (1/2) x Output gap © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 16 of 30 A Closer Look at the Fed’s Setting of Monetary Policy Targets CHAPTER 14: Monetary Policy Should the Fed Target Inflation? Inflation targeting Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 17 of 30 5 LEARNING OBJECTIVE Is the Independence of the Federal Reserve a Good Idea? The Case for Fed Independence CHAPTER 14: Monetary Policy The Case against Fed Independence 14 - 11 The More Independent the Central Bank, the Lower the Inflation Rate © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 18 of 30 CHAPTER 14: Monetary Policy Contractionary monetary policy Expansionary monetary policy Federal funds rate Inflation targeting Monetary policy Taylor rule © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. 19 of 30