Macro Chapter 14
Presentation 2- Expansionary and
Restrictive Monetary Policy
Expansionary Monetary Policy
(Easy $$)
• Used when the economy is facing recession
and unemployment
• The Fed will announce a lower target rate for
the Federal Funds rate
• They will use open market operations to buy
bonds which will increase M and decrease the
interest rate
• This will bolster borrowing and spending,
which will increase AD and output
Targeting the Federal Funds Rate
Federal Funds Rate, Percent
Using Open Market Operations
To Set The Federal Funds Rate
4.5
target
4.0
target
3.5
target
Df
Qf3
Qf1
Qf2
Quantity of Reserves
Monetary Policy
Expansionary Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Unemployment and Recession
Fed Buys Bonds, Lowers Reserve
Ratio, or Lowers the Discount Rate
Excess Reserves Increase
Federal Funds Rate Falls
Money Supply Rises
Interest Rate Falls
Investment Spending Increases
Aggregate Demand Increases
Real GDP Rises
Restrictive Monetary Policy (Tight
Money)
• Occurs during times of inflation
• Higher targeted Federal Funds Rate
• Increases the interest rate to reduce lending
and spending--- lowers money supply
• Reduces AD and holds down price level
increases
Monetary Policy
Restrictive Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Inflation
Fed Sells Bonds, Increases Reserve
Ratio, or Increases the Discount Rate
Excess Reserves Decrease
Federal Funds Rate Rises
Money Supply Falls
Interest Rate Rises
Investment Spending Decreases
Aggregate Demand Decreases
Inflation Declines
Advantages of Monetary over
Fiscal Policy
• 1. Speed and flexibility- don’t have to wait for
Congress
• 2. Isolation from political pressure
Problems with Monetary Policy
• 1. Lags (recognition and operational)
• 2. Cyclical Asymmetry- highly effective in
slowing inflation but not necessarily for
ending a recession because banks won’t
always lend more money