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Monetary Policy
By Teresa Stearns
Background Information

What is monetary policy?

Who conducts monetary policy?
• FOMC
Main Goals

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
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Price stability
High employment
Economic growth
Stabilize foreign exchange rates
Goals of Monetary Policy

Provide price stability
• Inflation-creates chain reaction

Supplier passes on to customer (Monaco
Coach)
• What does Fed do to counteract
inflation?

Increase interest rates
• Goal of zero inflation?
Goals of Monetary Policy
Slow growth of
money and
credit
Rapid growth of
money and
credit

People and
businesses
cannot
make major
purchases

Unemployment
and/or
recession

Economy
cannot
produce
goods and
services
fast enough

Inflation
Goals of Monetary Policy

Create high employment
• Is it reasonable to want full
employment?

No, because of frictional unemployment
• What happens when the unemployment
rate gets to high?


Stimulate economy by increasing money
supply
Decrease interest rate
Goals of Monetary Policy

Create economic growth
• Need to increase the output of goods
and services
• Needs to be steady and sustainable
• Provide high employment
• How can we stabilize the economy in
the short-run?

Decrease interest rates
Goals of Monetary Policy

Stability in foreign exchange rates
• What happens when Fed increases
interest rates?

Value of dollar rises
• Strong dollar vs Weak dollar
• Who benefits?
Goals of Monetary Policy
Value of dollar Impact on
imports/exports
Falls
Rises
Cost of imports rise
Cost of exports fall
Cost of imports fall
Cost of exports rises




Increases U.S. inflation
Boosts U.S. output
Decreases U.S. inflation
Reduces U.S. output
Tools used to implement
Monetary Policy



Reserve requirements
Discount window
Open market operations
Reserve Requirements

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Purpose?
Two components
• Required reserves



Vault cash
Reserve balances
Amounts are determined by required
reserve ratio
• Excess reserves

Can borrow from other banks in federal
funds market
Reserve Requirements

Increase in required reserves
• Reduces bank lending
• Decreases spending for consumers
• Businesses can’t expand

Decrease in required reserves
• Increases lending by banks
• More spending
• Increases employment
Discount Window

What is the discount window used
for?
• Banks can borrow from Fed when they
can’t meet their required reserve
amounts
• Borrow at discount rate

Set above federal funds rate
• Used as a last resort
Discount Window


Strict guidelines when borrowing
Many fear using discount window
• Produces bad image

Increase discount rate
• Slows economy

Decrease discount rate
• Stimulates economy
Open Market Operations

When the Fed buys and sells
government securities
• Transactions take place through Trading
Desk at NY Federal Reserve
• Huge dollar transactions

Impact of buying and selling……
Open Market Transactions
When the Fed Eases
When the Fed Tightens
Fed buys government securities from a firm that deals in
them.

Fed sells government securities to a firm that deals in
them.

It pays by crediting the account that the dealer’s bank has
at the Fed.

It pays by debiting the account that the dealer’s bank has
at the Fed.

The bank in turn credits the dealer’s account.

The bank in turn debits the dealer’s account.

The banking system has more funds to lend.

The banking system has fewer funds to lend.

Downward pressure on the federal funds rate—i.e. the
interest rate banks charge each other for overnight loans.

Upward pressure on the federal funds rate.
Influences the other interest rates in the economy—
which also go down.

Other interest rates in the economy also rise as a result.

Gives the economy a boost.

Slows the economy and curbs inflation.
Limitations of Monetary Policy

Does not have direct control over its
outcomes
• Primary use of interest rates

Lack up to the minute, reliable info
• Use of various models
• Revisions of data
Limitations of Monetary Policy

Unexpected changes in supply and
demand
• “shocks”

Trade-off in goals
• Which is more important?

Timing
• Can take months to years to see effects
Conclusion
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Must consider all factors before
announcing to public.
Can have huge impact with even the
slightest changes.
They can only forecast to the best of
their ability.
Biggest variable of all…..consumer.