Download Module Monetary Policy and the Interest Rate

Module 31
Monetary
Policy and
the Interest Rate
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How the Federal Reserve implements
monetary policy, moving the interest rate
to affect aggregate output
• Why monetary policy is the main tool for
stabilizing the economy
Jim Cramer’s Pleas to Ben Bernanke
The Fed Reverses Course
Monetary Policy and the Interest
Rate: Targeting the Fed Funds Rate
Expansionary Monetary Policy
The Economy
The
Money
Market
Contractionary Monetary Policy
The
Money
Market
The Economy
Fed Policy and the Output Gap
• The Federal Reserve engages in
expansionary monetary policy
(they lower the interest rate)
when the output gap (the
difference between potential
RGDP and actual GDP)
becomes negative.
• The Federal Reserve engages in
contractionary monetary policy
(they raise the interest rate)
when the output gap becomes
positive.
Stanford Economist, John Taylor
Fed Policy and the Inflation Rate
• The Federal Reserve
engages in expansionary
monetary policy (they lower
the interest rate) when the
inflation rate falls.
• The Federal Reserve
engages in contractionary
monetary policy (they raise
the interest rate) when the
inflation rate rises.
Stanford Economist, John Taylor
Monetary Policy in Practice
• Stanford economist
John Taylor proposes
that the Fed follow a
rule
• Fed Funds = ...
• 1+(1.5 X π%)+(0.5 X Output Gap)
**(π%) represents the inflation rate
Stanford Economist, John Taylor
Monetary Policy in Practice
• In practice it appears that the
Fed does follow the Taylor
rule.
• The Taylor rule reflects more
closely what the Fed actually
does with the Federal Funds
rate
Stanford Economist, John Taylor
Inflation Targeting
•The Fed tries to keep inflation low but positive
•The Fed does not explicitly commit itself to a particular rate of
inflation
•Inflation Targeting (setting a target inflation rate or range) is
the policy of other countries’ central banks
•Pros of inflation targeting argue that it makes Fed policy more
transparent and keeps the Fed accountable
•Opponents argue that it limits the Fed to dealing only with
inflation when there may be other concerns