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Chapter 23 Monetary Policy, Output, and Inflation in the Short Run McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Japanese and U.S. Growth and Interest Rates, 1990–2004 23-2 Japanese and U.S. Growth and Interest Rates, 1990–2004 23-3 Japanese and U.S. Growth and Interest Rates, 1990–2004 23-4 Japanese and U.S. Growth and Interest Rates, 1990–2004 23-5 The Monetary Policy Transmission Mechanism • The Traditional Channels: Interest Rates and Exchange Rates • the traditional channels of monetary policy transmission aren’t very powerful 23-6 The Monetary Policy Transmission Mechanism • Asset Price Channels: Investment and Wealth • a fall in the interest rate tends to push stock prices up • A fall in interest rate target it drives the mortgage rate down leading to higher demand for residential housing, driving up the prices of existing homes • Higher asset prices mean increased wealth and higher consumption 23-7 The Monetary Policy Transmission Mechanism • Bank Lending and Balance Sheet Channels • By altering the supply of funds to the banking system, policymakers can affect banks' ability and willingness to lend. • an open market purchase has a direct impact on the supply of loans, increasing their availability to those who depend on banks for financing. • as interest rates fall, the supply of loans increases 23-8 The Monetary Policy Transmission Mechanism 23-9 The Challenges Modern Monetary Policymakers Face Estimating Potential GDP 23-10 The Challenges Modern Monetary Policymakers Face U.S. Inflation, 1960–1980 23-11 The Challenges Modern Monetary Policymakers Face 23-12 The Challenges Modern Monetary Policymakers Face • Deflation and the Zero Nominal Interest Rate Bound • Since nominal interest rates can't fall below zero, this places a significant restriction on what monetary policymakers can do • The most effective way to expand the monetary base when the overnight interest rate has fallen to zero is to shift to targeting longer-term rates. 23-13 The Challenges Modern Monetary Policymakers Face • Booms and Busts in Equity and Property Prices • Bubbles that inflate and then burst are particularly damaging, because the wealth effects they create cause consumption to explode and then contract just as rapidly. 23-14 The Challenges Modern Monetary Policymakers Face 23-15 The Challenges Modern Monetary Policymakers Face • The Evolving Structure of the Financial System • changes in financial structure will change the impact of monetary policy. 23-16 The Challenges Modern Monetary Policymakers Face 23-17 Chapter 23 End of Chapter McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.