Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Fiscal multiplier wikipedia , lookup
Fractional-reserve banking wikipedia , lookup
Real bills doctrine wikipedia , lookup
Modern Monetary Theory wikipedia , lookup
Monetary policy wikipedia , lookup
Quantitative easing wikipedia , lookup
Interest rate wikipedia , lookup
29 Monetary Policy and the National Economy Victorians heard with grave attention that the Bank Rate had been raised. They did not know what it meant. But they knew that it was an act of extreme wisdom. JOHN KENNETH GALBRAITH Contents ● Money and Income: The Important Difference ● America’s Central Bank: The Federal Reserve System ● Implementing Monetary Policy: Open Market Operations ● Other Methods of Monetary Control Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Contents (continued) ● Supply-Demand Analysis of the Money Market ● How Monetary Policy Works ● Money and the Price Level in the Keynesian Model ● From Models to Policy Debates Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Money and Income: The Important Difference ● Stock variables are measured at a moment in time. ● Flow variables are measured over time. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Money and Income: The Important Difference ● Money is a stock, income a flow. ♦ Stock of money influences the rate at which people earn income. ♦ Money affects GDP. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. America’s Central Bank: The Federal Reserve System ● The Federal Reserve System, established in 1914, is the U.S. central bank. ♦ Comprised of twelve district banks ♦ Governed by a seven-member Board of Governors ♦ Decisions on the money supply made by the Federal Open Market Committee Copyright© 2003 South-Western/Thomson Learning. All rights reserved. America’s Central Bank: The Federal Reserve System ● Central Bank Independence ♦ Fed board members: ■Appointed to fourteen-year terms ■Independent of political pressures Copyright© 2003 South-Western/Thomson Learning. All rights reserved. America’s Central Bank: The Federal Reserve System ● Central Bank Independence ♦ In some other countries, the central banks are less independent. ♦ Countries without independent central banks often have less stable economies. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Implementing Monetary Policy ● The Fed can increase the money supply by buying government securities on the open market. ♦ It pays for these securities by creating new bank reserves. ♦ These additional reserves multiple expansion of the money supply ● To reduce the money supply, the Fed sells securities. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-1 Effects of an OpenMarket Purchase of Securities TABLE Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Implementing Monetary Policy ● Open-Market Operations, Bond Prices and Interest Rates ● When the Fed buys bonds: ♦ demand for bonds ♦ price of bonds ● price of bonds = interest rate ● Opposite when Fed sell bonds Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-1 Open-Market Sales and Bond Prices FIGURE Price of a Bond D P S 0 S1 A 0 P 1 B S 0 S1 D Quantity of Bonds Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Other Methods of Monetary Control ● Lending to Banks ♦ The Fed lends to member banks, occasionally as a “lender of last resort.” ♦ Discount rate = interest rate Fed charges member banks when it makes loans to them Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Other Methods of Monetary Control ● Lending to Banks ♦ discount rate ■ Borrowing by member banks ■ Reserves ■ Money supply ♦ Opposite if Fed raises discount rate Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-2 Balance Sheet Changes, Borrowing from Fed TABLE Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Other Methods of Monetary Control ● Changing Reserve Requirements ♦ Required reserve ratio ■ Excess reserves ■ Loans ■ Money supply ♦ Opposite if Fed increases reserve requirement ♦ In practice, the Fed seldom changes the reserve requirements. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Supply-Demand Analysis of the Money Market ● Interest rates ♦ Profit opportunities for banks ♦ Excess reserves ♦ Volume of loans Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Supply-Demand Analysis of the Money Market ● However, the Fed can shift the relationship between the money supply and interest rates by employing any of its principal weapons of monetary control. ♦ Open-market operations ♦ reserve requirements ♦ lending policy to banks Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-2 (a) The Supply Schedule for Money FIGURE 7 S Interest Rate 5 3 1 M 0 800 820 830 Money Supply 850 (a) Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. 29-2 (b, c) The Supply Schedule for Money FIGURE 7 S0 7 S1 3 1 3 1 M0 0 S0 5 Interest Rate Interest Rate 5 S2 800 M1 M2 850 Money Supply Expansionary Policy Change (b) 0 800 M0 850 Money Supply Contractionary Policy Change (c) Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Supply-Demand Analysis of the Money Market ● The Money Supply Mechanism ♦ Money supply curve: slightly positive slope ♦ Indicates a weak sensitivity to changes in the interest rate Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Supply-Demand Analysis of the Money Market ● The Demand for Money ♦ Money is demanded for transactions. ♦ nominal GDP ■ Spending ■ Demand for money Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Supply-Demand Analysis of the Money Market ● The Demand for Money ♦ Interest = opportunity cost of holding money ■ Interest rates Money demand ♦ Demand curve for money curve ■Negatively sloped ■Shifts as nominal GDP changes Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-3 (a) The Demand Schedule for Money FIGURE Interest Rate M D Quantity of Money Demanded (a) Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. 29-3 (b, c) The Demand Schedule for Money FIGURE M1 M0 M0 Interest Rate Interest Rate M2 D1 D0 Quantity of Money Demanded HigherY or P (b) D2 D0 Quantity of Money Demanded LowerY or P (c) Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Supply-Demand Analysis of the Money Market ● Equilibrium in the Money Market ♦ The interest rate equilibrates the demand and supply of money. ♦ The Fed can lower (raise) interest rates by increasing (reducing) the money supply. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-4 Equilibrium in the Money Market FIGURE 8 M S For given Fed policy 7 Interest Rate 6 E 5 4 3 For given Y and P 2 1 0 D M 800 830 Money Stock 850 Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. 29-5 Effects of Monetary Policy on the Money Market FIGURE Interest Rate E A M0 S2 M S1 Interest Rate S0 M D M1 S0 B E M2 D M0 Money Stock (a) Money Stock (b) Expansionary Monetary Policy Contractionary Monetary Policy Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. How Monetary Policy Works ● Of the four components of aggregate demand, investment and net exports are the most sensitive to monetary policy. ● Assume that net exports (X - IM) are fixed. ● Focus on monetary policy’s influence on investment (I) Copyright© 2003 South-Western/Thomson Learning. All rights reserved. How Monetary Policy Works ● Investment and Interest Rates ♦ interest rates investment spending ♦ investment multiplier effect ■Lowers GDP ♦ interest rates opposite Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-6 Effect of Interest Rates on Total Expenditure FIGURE 45 Real Expenditure C + I + G + (X – IM ) (lower interest rate) C + I + G + (X – IM ) C + I + G + (X – IM ) (higher interest rate) Real GDP Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. How Monetary Policy Works ● Monetary Policy and Total Expenditure ♦ Fed actions ■ money supply ■ interest rates ♦ interest rate investment ♦ investment AD ♦ AD GDP Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-7 Expansionary Policy on Money Supply & Interest Rate FIGURE 7 S0 Interest Rate M 5 S1 E0 3 E1 D 1 M0 M1 800 830 850 Money Stock 880 900 Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. How Monetary Policy Affects GDP 1 Federal Reserve Policy 2 M and r 3 I 4 C + I + G + (X - IM) GDP Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. 29-8 Expansionary Policy on Total Expenditure FIGURE 45 E1 C + I1 + G + (X – IM) Real Expenditure C + I0 + G + (X – IM) $200 billion E0 5,500 6,000 6,500 Real GDP 7,000 Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Money and the Price Level in the Keynesian Model ● Expansionary monetary policy causes some inflation under normal circumstances. ● How much inflation it causes depends on the state of the economy. ♦ Represented by the slope of the AS curve Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 29-9 The Inflationary Effects of Expansionary Policy FIGURE D0 D1 S Price Level $500 billion B 103 E 100 S D0 6,000 D1 6,400 Real GDP Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Money and the Price Level in the Keynesian Model ● Fed policy ♦M&r ♦ AD ♦Y&P ● Both output and prices are normally affected by monetary policy. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Effect of Monetary Policy on Output and Prices 1 Federal Reserve Policy 2 M and r 3 I 4 C + I + G + (X - IM) Y and P Copyright © 2003 South-Western/Thomson Publishing. All rights reserved. Money and the Price Level in the Keynesian Model ● Application: Why the AD Curve Slopes Downward ♦ price level ■ money demand ■ interest rates ■ investment Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Money and the Price Level in the Keynesian Model ● Application: Why the AD Curve Slopes Downward ♦ investment negative multiplier effect on GDP ♦ Thus price level GDP Copyright© 2003 South-Western/Thomson Learning. All rights reserved. From Models to Policy Debates ● We have done all the theory that is needed. ● The next three chapters of the text turn to policy debates. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.