Download Monetary Policy Introduction Notes

Winthrop University
College of Business Administration
Money and Banking
What are the current practices regarding monetary theories?
Fed Governor Lawrence Meyer
1. Monetary Policy cannot influence real variables in the long run.
This is consistent with Fisher, and Rational Expectations.
2. Monetary Policy determines inflation in the long run.
This is consistent with Fisher, Friedman, and Rational Expectations
3. Slow adjustment of prices and wages enable economic shocks to lead to persistent
departures of the economy from full employment. In other words, some policy (surprise)
can have real effects.
The first sentence is consistent with Keynes and to some extent Friedman. Its
implications (the second sentence) are consistent with Rational Expectations.
4. Full Employment and price stability are compatible; therefore, if unemployment
remains constant so will inflation. In other words, there is a natural rate of unemployment
where inflation is constant.
This is consistent with Friedman and Rational Expectations
5. Inflation will result when the economy departs from full employment.
In summary, we can say that current policy is based on the theories developed by Keynes,
Fisher, Friedman and others, but refined to include rational expectations – as opposed to
adaptive expectations. Fisher added the relationship between money and prices. Keynes
added the impact that changing the money supply can have in the short run. Later on
economists claimed this changing of the money supply would have greater and longer
lasting effects if the change was unannounced and unanticipated. Keynes also added that
prices and wages are slow to adjust. Friedman added the consistent monetary policy is
good for price stability, and that the economy will adjust to some natural rate of
unemployment where inflation is constant. The modern monetarists incorporate rational
expectations to support their theory that surprise policies have real effects on the
economy. The question remains, how long does the real effect persist (last)?
Friedman thought money can have negative effects on the economy in the short run. He
also thought that money caused inflation. And, money should not be used as a tool for
growth because it can do short term damage because of the timing and impact problems.
Over time money just causes inflation.
Functions of the Fed
1) clear checks (banks have accounts at the Fed)
2) issue new currency
3) withdraw damaged currency
4) evaluate some merger applications
5) administer and make discount loans
6) act as liaisons between business ? + Fed
7) examine state member banks
8) collect data on local business conditions
9) conduct research on monetary policy + regional economics
Member banks
All national banks
Commercial banks w/state charters have the option (40%)
Non-member banks are now required to keep deposits at the Fed (since 1987). Not much
of a distinction between member and non-member banks.
What does the Fed give in return?
Check clearing and discount window access.
Members of the Board of Governors
The seven members of the Board of Governors of the Federal Reserve System are
nominated by the Presidents and confirmed by the Senate. A full term is fourteen years.
One term begins every two years, on February 1 of even-numbered years. A member who
serves a full term may not be reappointed. A member who completes an unexpired
portion of a term may be reappointed. All terms end on their statutory date regardless of
the date on which the member is sworn into office.
The Chairman and Vice Chairman of the Board are named by the President from among
the members and are confirmed by the Senate. They serve a term of four years. A
member’s term on the Board is not affected by his or her status as Chairman of Vice
Chairman.
Open Market Operations
Open market operations – purchases and sales of U.S. Treasury and federal agency
securities – are the Federal Reserve’s principal tool for implementing monetary policy.
The short-term objective for open market operations is specified by the Federal Open
Market Committee (FOMC). This objective can be a desired quantity of reserves or a
desired price (the federal funds rate). The federal funds rate is the interest rate at whicn
depository institutions lend balances at the Federal Reserve to other depository
institutions overnight.
The Federal Reserve’s objective for open market operations has varied over the years.
During the 1980s, the focus gradually shifted toward attaining a specified level of the
federal funds rate, a process that was largely complete by the end of the decade.
Beginning in 1994, the FOMC began announcing changes in its policy stance, and in
1995 it began to explicitly state its target level for the federal funds rate. Since February
2000, the statement issued by the FOMC shortly after each of its meetings usually has
included the Committee’s assessment of the risks to the attainment of its long-run goals
of price stability and sustainable economic growth.
Discount Loans
Adjustment credit loans are used by banks to help them with short term liquidity
problems.
Seasonal Credit Loans are designed to benefit season type businesses.
Extended Credit Loans are designed to help banks that have experienced severe
liquidity problems. There are not going to be paid back quickly.
This money is not to be used for lending and profiting.
Features of Discount Rates
Lender of Last Resort
Announcement Effect if interpretation is correct
Disadvantages
Fed does not control borrowing, it just controls the rate
Should it be a penalty rate?
Does the FDIC eliminate the need for the discount window?
Reserve Requirement
The effect of reserve requirement on the money multiplier.
3 percent of the first 44 million
10 percent above that April 1992 from 12 to 10 percent
Range 8 to 14
All banks are impacted
Should reverse requirements be abolished?
Winthrop University
College of Business Administration
Money and Banking
Summary Notes
Goals of Monetary Policy
High Employment
Full Employment and Balanced Growth Act of 1978 (HumphreyHawkins Act)
Economic Growth
Price Stability
Interest Rate Stability
Stability of Financial Markets
Stability of Foreign Exchange Markets
Do some of these goals conflict?
1. Tools of the Central Bank
2. Operating Targets
3. Intermediate Targets
4. Goals
What are the attributes that targets should possess?
Measurability
Controllability
Predictable Effect on goals
This is why we investigated the relationships at the beginning of the semester
1. Tools of the Central Bank
Reserve Ratio
Discount Rate
Open market operations – what is bought and sold?
Which tool is most commonly used?