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Monetary Policy
Introduction to Monetary Policy
Monetary Policy Tools
Impacts of Federal Reserve Policies
Historical Federal Reserve Policies
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Monetary Policy > Introduction to Monetary Policy
Introduction to Monetary Policy
• The Demand for Money
• Shifts in the Money Demand Curve
• The Equilibrium Interest Rate
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Monetary Policy > Monetary Policy Tools
Monetary Policy Tools
• The Reserve Ratio
• The Discount Rate
• The Federal Funds Rate
• Open Market Operations
• Setting and Achieving the Interest Rate Target
• Executing Expansionary Monetary Policy
• Executing Restrictive Monetary Policy
• The Taylor Rule
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Monetary Policy > Impacts of Federal Reserve Policies
Impacts of Federal Reserve Policies
• The Impact of Monetary Policy on Aggregate Demand, Prices, and
Real GDP
• The Effect of Expansionary Monetary Policy
• The Effect of Restrictive Monetary Policy
• Limitations of Monetary Policy
• Using Monetary Policy to Target Inflation
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Monetary Policy > Historical Federal Reserve Policies
Historical Federal Reserve Policies
• Volcker Disinflation
• Greenspan Era
• Bernanke Era
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Appendix
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Monetary Policy
Key terms
• aggregate demand The the total demand for final goods and services in the economy at a given time and price level.
• asset Something or someone of any value; any portion of one's property or effects so considered.
• asset Something or someone of any value; any portion of one's property or effects so considered.
• consumer price index A statistical estimate of the level of prices of goods and services bought for consumption purposes by
households.
• contractionary monetary policy Central bank actions designed to slow economic growth.
• deflation A decrease in the general price level, that is, in the nominal cost of goods and services.
• deflation A decrease in the general price level, that is, in the nominal cost of goods and services.
• discount rate An interest rate that a central bank charges to depository institutions that borrow reserves from it.
• equilibrium The condition of a system in which competing influences are balanced, resulting in no net change.
• expansionary monetary policy Traditionally used to try to combat unemployment in a recession by lowering interest rates in the
hope that easy credit will entice businesses into expanding.
• fed funds rate Short for Federal Funds rate. The interest rate at which depository institutions actively trade balances held at the
Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.
• fed funds rate Short for Federal Funds rate. The interest rate at which depository institutions actively trade balances held at the
Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.
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Monetary Policy
• fed funds rate Short for Federal Funds rate. The interest rate at which depository institutions actively trade balances held at the
Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.
• fed funds target rate The interest rate at which depository institutions actively trade balances held at the Federal Reserve,
called federal funds, with each other, usually overnight, on an uncollateralized basis.
• federal funds rate The interest rate at which depository institutions actively trade balances held at the Federal Reserve with
each other.
• financial crisis A period of serious economic slowdown characterized by devaluing of financial institutions often due to reckless
and unsustainable money lending.
• full employment A state when an economy has no cyclical or deficient-demand unemployment.
• inflation An increase in the general level of prices or in the cost of living.
• inflation An increase in the general level of prices or in the cost of living.
• interest rate The percentage of an amount of money charged for its use per some period of time (often a year).
• interest rate The percentage of an amount of money charged for its use per some period of time (often a year).
• loanable funds Money available to be issued as debt.
• monetary policy The process by which the central bank, or monetary authority manages the supply of money, or trading in
foreign exchange markets.
• money supply The total amount of money (bills, coins, loans, credit, and other liquid instruments) in a particular economy.
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Monetary Policy
• money supply The total amount of money (bills, coins, loans, credit, and other liquid instruments) in a particular economy.
• nominal interest rate The rate of interest before adjustment for inflation.
• open market operations An activity by a central bank to buy or sell government bonds on the open market. A central bank uses
them as the primary means of implementing monetary policy.
• open market operations An activity by a central bank to buy or sell government bonds on the open market. A central bank uses
them as the primary means of implementing monetary policy.
• open market operations An activity by a central bank to buy or sell government bonds on the open market. A central bank uses
them as the primary means of implementing monetary policy.
• open market operations An activity by a central bank to buy or sell government bonds on the open market. A central bank uses
them as the primary means of implementing monetary policy.
• reserve Banks' holdings of deposits in accounts with their central bank.
• reserve ratio A central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum
fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out).
• reserve requirement The minimum amount of deposits each commercial bank must hold (rather than lend out).
• stagflation Inflation accompanied by stagnant growth, unemployment, or recession.
• Taylor Rule A way of determining the appropriate change in interest rates for a given change in inflation.
• unemployment The state of being jobless and looking for work.
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Monetary Policy
Federal Funds Rate
This graph shows the fluctuations in the federal funds rate from 1954-2009. The Federal Reserve implements monetary policy through the federal funds
rate.
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Monetary Policy
Shift of the Demand Curve
The graph shows both the supply and demand curve, with quantity of money on the x-axis (Q) and the price of money as interest rates on the y-axis (P).
When the quantity of money demanded increase, the price of money (interest rates) also increases, and causes the demand curve to increase and shift
to the right. A decrease in demand would shift the curve to the left.
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Wikipedia. "Supply-and-demand." GNU FDL http://en.wikipedia.org/wiki/File:Supply-and-demand.svg View on Boundless.com
Monetary Policy
Fluctuation in Interest Rates
This graph shows the fluctuation in interest rates in Germany from 1967 to 2003. Interest rates fluctuate over time as the result of numerous factors. In
Germany, the interest rates dropped from 14% in 1967 to almost 2% in 2003. This graph illustrates the fluctuations that can occur in the short-run and
long-run. Interest rates fluctuate based on certain economic factors.
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Wikipedia. "German bank interest rates from 1967 to 2003 grid." Public domain
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Monetary Policy
Federal Reserve-US Central Bank
The Federal Reserve is charged with maintaining sustainable economic growth. To carry out its responsibilities, the "Fed" uses policies including the
reserve ratio to adjust the money supply to either incentivize growth or slow down growth, as needed.
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Wikimedia. CC BY-SA http://upload.wikimedia.org/wikipedia/commons/thumb/f/f4/Federal_Reserve.jpg/800px-Federal_Reserve.jpg View on Boundless.com
Monetary Policy
Historical discount and fed fund target rates
The discount rate is higher than the fed funds target rate and the variance serves as a disincentive for banks to seek funds or short-term borrowings from
the Fed.
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Wikipedia. "Discount window." GNU FDL http://en.wikipedia.org/wiki/Discount_window View on Boundless.com
Monetary Policy
US Treasury Bill Yields
By buying and selling US Treasury bills on the open market, the Federal Reserve hopes to change their yields, which will then affect the interest rates in
the broader market.
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Wikimedia. "US Treasury bills and bonds yield." CC BY http://commons.wikimedia.org/wiki/File:US_Treasury_bills_and_bonds_yield.png View on Boundless.com
Monetary Policy
Historical effective federal funds target rate
The graphic depicts the movement in the effective federal funds target rate. The target rate has historically been set in terms of a range; the current
range as depicted in the graph is 0.00 to 0.25 percent.
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Wikimedia. CC BY http://upload.wikimedia.org/wikipedia/commons/thumb/3/31/Federal_Funds_Rate_1954_thru_2009_effective.svg/640pxFederal_Funds_Rate_1954_thru_2009_effective.svg.png View on Boundless.com
Monetary Policy
Relationship between money supply and interest rates
As money supply increases, the interest rate decreases, as depicted in the graph above.
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Boundless Learning. "Boundless." CC BY-SA 3.0 https://figures.boundless.com/332/large/money-supply.jpeg View on Boundless.com
Monetary Policy
Contractionary monetary policy
Contractionary monetary policy results in a reduction in the money supply, depicted as a leftward shift, which results in an increase in interest rates as
well as a decrease in the quantity of loanable funds.
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Monetary Policy
Professor John Taylor
Stanford University Professor John Taylor is the creator of the Taylor Rule, a monetary policy instrument developed to promote stable economic growth
and limit short-run economic disruption related to inflation.
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Monetary Policy
Aggregate Demand Graph
This graph shows the effect of expansionary monetary policy, which shifts aggregate demand (AD) to the right.
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Wikipedia. "AS AD graph." CC BY-SA http://en.wikipedia.org/wiki/File:AS_%252B_AD_graph.svg View on Boundless.com
Monetary Policy
Bank of England Interest Rates
The Bank of England (the central bank in England) undertook expansionary monetary policy and lowered interest rates, promoting investment.
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Wikimedia. "Interest rates (1997-2010)." CC BY-SA http://commons.wikimedia.org/wiki/File:Interest_rates_(1997-2010).png View on Boundless.com
Monetary Policy
Business cycle
Restrictive monetary policy is used during expansion and boom periods in the business cycle to prevent the overheating of the economy.
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Wikimedia. "Economic cycle." Public domain http://commons.wikimedia.org/wiki/File:Economic_cycle.svg View on Boundless.com
Monetary Policy
Liquidity Trap
Sometimes, when the money supply is increased, as shown by the Liquidity Preference-Money Supply (LM) curve shift, it has no impact on output (GDP
or Y) or on interest rates. This is a liquidity trap.
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Wikipedia. "Liquidity trap IS-LM." CC BY-SA http://en.wikipedia.org/wiki/File:Liquidity_trap_IS-LM.svg View on Boundless.com
Monetary Policy
Fed Reserve Seal
The United States Federal Reserve uses a form of inflation targeting when coordinating its monetary policy.
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Wikipedia. "US-FederalReserveSystem-Seal." Public domain http://en.wikipedia.org/wiki/File:US-FederalReserveSystem-Seal.svg View on Boundless.com
Monetary Policy
Paul Volcker
Paul Volcker was the 12th Chairman of the Federal Reserves. He became known for decreasing inflation during the early 1980s.
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Monetary Policy
Alan Greenspan
Alan Greenspan was the 13th Chairman of the Federal Reserve. He held the position from 1987 until 2006. His tenure as the chairman was marked by
low interest rates which eventually were blamed for the 2007 mortgage crisis in the United States.
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Wikipedia. "Alan Greenspan color photo portrait." Public domain http://en.wikipedia.org/wiki/File:Alan_Greenspan_color_photo_portrait.jpg View on Boundless.com
Monetary Policy
Ben Bernanke
Ben Bernanke (right) was appointed chairman of the Federal Reserve by President Bush and he was reappointed by President Obama. Throughout his
time as chairman, Bernanke has influenced the financial crisis, the Wall Street bailout, and the economic stimulus.
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Wikipedia. "President Barack Obama meets with Federal Reserve Chairman Ben Bernanke 4-10-09." Public domain
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Monetary Policy
Federal Funds Rate 1954-2009
The graph shows the federal funds rate for the past fifty years. The peak in the 1980s reflects the contractionary monetary policy the Fed instituted to
combat high levels of inflation due to oil shocks, and the low rate in the late 2000s reflects expansionary monetary policy meant to combat the effects of
recession.
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Monetary Policy
Suppose the rate of return paid on bonds rises. What will happen
to the demand for money and the interest rate?
A) The demand for money will fall and the interest rate will increase
B) The demand for money will fall and the interest rate will decrease
C) The demand for money will rise and the interest rate will increase
D) The demand for money will rise and the interest rate will decrease
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Monetary Policy
Suppose the rate of return paid on bonds rises. What will happen
to the demand for money and the interest rate?
A) The demand for money will fall and the interest rate will increase
B) The demand for money will fall and the interest rate will decrease
C) The demand for money will rise and the interest rate will increase
D) The demand for money will rise and the interest rate will decrease
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Monetary Policy
Which of the following statements about a shift in the money
demand curve is NOT true?
A) The demand curve shifts to the right when demand for money
increases
B) The price of money is measured by the interest rate.
C) Demand for money determines how a person's wealth should be held
D) Money is not an interest-bearing asset
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Monetary Policy
Which of the following statements about a shift in the money
demand curve is NOT true?
A) The demand curve shifts to the right when demand for money
increases
B) The price of money is measured by the interest rate.
C) Demand for money determines how a person's wealth should be held
D) Money is not an interest-bearing asset
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Monetary Policy
Assume there is an influx of immigration and demand for money
shifts outward. What would happen?
A) The supply of money would increase and interest rates would increase
B) The supply of money would remain constant and interest rates would
increase
C) The supply of money would increase and interest rates would remain
constant
D) The supply of money would remain constant and interest rates would
decrease
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Monetary Policy
Assume there is an influx of immigration and demand for money
shifts outward. What would happen?
A) The supply of money would increase and interest rates would increase
B) The supply of money would remain constant and interest rates would
increase
C) The supply of money would increase and interest rates would remain
constant
D) The supply of money would remain constant and interest rates would
decrease
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Monetary Policy
Suppose the reserve requirement at all US banks was raised on
all deposits. Which of the following effects would most likely
occur?
A) An increase in the money supply
B) A decrease in the money supply
C) A decrease, then increase in the monetary supply
D) An increase, then decrease in the monetary supply
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Monetary Policy
Suppose the reserve requirement at all US banks was raised on
all deposits. Which of the following effects would most likely
occur?
A) An increase in the money supply
B) A decrease in the money supply
C) A decrease, then increase in the monetary supply
D) An increase, then decrease in the monetary supply
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Monetary Policy
The discount window best illustrates the Federal Reserve's role
as which of the following?
A) Buyer/Seller of securities
B) Lender of last resorts
C) Manager of government finances
D) Facilitator of inter-bank lending
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Monetary Policy
The discount window best illustrates the Federal Reserve's role
as which of the following?
A) Buyer/Seller of securities
B) Lender of last resorts
C) Manager of government finances
D) Facilitator of inter-bank lending
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Monetary Policy
Why might the Federal Reserve target a low federal funds rate?
A) In order to slow economic activity to fight inflation
B) In order to increase economic activity in a recession
C) In order to decrease the money supply
D) In order to decrease the number of loans issued by banks
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Monetary Policy
Why might the Federal Reserve target a low federal funds rate?
A) In order to slow economic activity to fight inflation
B) In order to increase economic activity in a recession
C) In order to decrease the money supply
D) In order to decrease the number of loans issued by banks
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Monetary Policy
What is the primary goal of open market operations?
A) To increase reserves at the Federal Reserve Bank of New York
B) To increase the money supply and the money multiplier effect
C) To sell securities to primary dealers and collect the deposits
D) To control the short term interest rate and supply of base money
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Monetary Policy
What is the primary goal of open market operations?
A) To increase reserves at the Federal Reserve Bank of New York
B) To increase the money supply and the money multiplier effect
C) To sell securities to primary dealers and collect the deposits
D) To control the short term interest rate and supply of base money
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Monetary Policy
In open market operations, the Fed attempts to change the
_________ through the sale or purchase of US Treasury
Securities.
A) interest rate
B) Federal Funds rate
C) permanent supply of reserves
D) monetary policy
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Monetary Policy
In open market operations, the Fed attempts to change the
_________ through the sale or purchase of US Treasury
Securities.
A) interest rate
B) Federal Funds rate
C) permanent supply of reserves
D) monetary policy
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Monetary Policy
What are two policy tools that the Fed can use directly in order to
increase economic growth?
A) reserve requirement and open market operations
B) fed funds target rate and open market operations
C) fed funds target rate and open market operations
D) reserve requirement and fed funds rate
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Monetary Policy
What are two policy tools that the Fed can use directly in order to
increase economic growth?
A) reserve requirement and open market operations
B) fed funds target rate and open market operations
C) fed funds target rate and open market operations
D) reserve requirement and fed funds rate
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Monetary Policy
What is the net impact of restrictive monetary policy?
A) slower economic growth
B) increased interest rates
C) all of the below
D) lower money supply
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Monetary Policy
What is the net impact of restrictive monetary policy?
A) slower economic growth
B) increased interest rates
C) all of the below
D) lower money supply
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Monetary Policy
The Taylor rule is a monetary policy instrument that seeks to
control _________ by adjusting ____________.
A) interest rates, inflation
B) GDP, inflation
C) inflation, interest rates
D) inflation, GDP
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Monetary Policy
The Taylor rule is a monetary policy instrument that seeks to
control _________ by adjusting ____________.
A) interest rates, inflation
B) GDP, inflation
C) inflation, interest rates
D) inflation, GDP
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Monetary Policy
If a country enacts an expansionary monetary policy, consumer
spending will ____, causing aggregate demand to shift to the
____.
A) increase, right.
B) decrease, left.
C) increase, left.
D) decrease, right.
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Monetary Policy
If a country enacts an expansionary monetary policy, consumer
spending will ____, causing aggregate demand to shift to the
____.
A) increase, right.
B) decrease, left.
C) increase, left.
D) decrease, right.
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Monetary Policy
An expansionary monetary policy will generally ______.
A) decrease unemployment and decrease inflation.
B) decrease unemployment and increase inflation.
C) increase unemployment and increase inflation.
D) increase unemployment and decrease inflation.
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Monetary Policy
An expansionary monetary policy will generally ______.
A) decrease unemployment and decrease inflation.
B) decrease unemployment and increase inflation.
C) increase unemployment and increase inflation.
D) increase unemployment and decrease inflation.
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Monetary Policy
A restrictive monetary policy will generally ______.
A) decrease unemployment and increase inflation.
B) increase unemployment and decrease inflation.
C) decrease unemployment and decrease inflation.
D) increase unemployment and increase inflation.
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Monetary Policy
A restrictive monetary policy will generally ______.
A) decrease unemployment and increase inflation.
B) increase unemployment and decrease inflation.
C) decrease unemployment and decrease inflation.
D) increase unemployment and increase inflation.
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Monetary Policy
Which of the following is a weakness of monetary policy?
A) Deflation.
B) Liquidity traps.
C) All of these answers.
D) Being canceled out by other factors.
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Monetary Policy
Which of the following is a weakness of monetary policy?
A) Deflation.
B) Liquidity traps.
C) All of these answers.
D) Being canceled out by other factors.
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Monetary Policy
Which of the following is a benefit of inflation targeting?
A) Governments are more responsive to output shocks.
B) Inflation is a good measure of economic health because it is coupled
to a country's internal economic factors.
C) All of these answers.
D) Increased economic stability through predictable interest rate
changes.
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Monetary Policy
Which of the following is a benefit of inflation targeting?
A) Governments are more responsive to output shocks.
B) Inflation is a good measure of economic health because it is coupled
to a country's internal economic factors.
C) All of these answers.
D) Increased economic stability through predictable interest rate
changes.
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Monetary Policy
Why did Federal Reserve chairman Paul Volcker raise interest
rates in late '70s and early '80s?
A) To combat high employment
B) To prevent an asset bubble
C) To combat high inflation
D) To prevent a financial crisis
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Monetary Policy
Why did Federal Reserve chairman Paul Volcker raise interest
rates in late '70s and early '80s?
A) To combat high employment
B) To prevent an asset bubble
C) To combat high inflation
D) To prevent a financial crisis
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Monetary Policy
Some claim that the stock market bubble burst in 2000 because
Alan Greenspan _________.
A) lowered interest rates
B) grew the Fed balance sheet
C) raised interest rates
D) shrank the Fed balance sheet
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Monetary Policy
Some claim that the stock market bubble burst in 2000 because
Alan Greenspan _________.
A) lowered interest rates
B) grew the Fed balance sheet
C) raised interest rates
D) shrank the Fed balance sheet
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Monetary Policy
Since Bernanke was appointed chairman of the Board of
Governors in 2006, the Fed has taken strong measures to support
market liquidity and stimulate economic activity. What events was
the Fed responding to?
A) The collapse of large financial institutions and very high
unemployment levels
B) The collapse of large financial institutions and a worldwide depression
C) Record high interest rates and high unemployment levels
D) Record high inflation rates and a collapse in the average hours
worked per week
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Monetary Policy
Since Bernanke was appointed chairman of the Board of
Governors in 2006, the Fed has taken strong measures to support
market liquidity and stimulate economic activity. What events was
the Fed responding to?
A) The collapse of large financial institutions and very high
unemployment levels
B) The collapse of large financial institutions and a worldwide depression
C) Record high interest rates and high unemployment levels
D) Record high inflation rates and a collapse in the average hours
worked per week
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Monetary Policy
Attribution
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Monetary Policy
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Monetary Policy
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Monetary Policy
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Monetary Policy
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