Chapter 15 Monetary Policy
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Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level 15 C HAPTE R Monetary Policy and Equilibrium GDP Monetary Policy Monetary Policy in Action Problems and Complications FEDERAL RESERVE BANK OF THE U.S. Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 1 Next Slide Copyright McGraw-Hill/Irwin, 2005 GOALS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 2 Next Slide …to assist the economy in achieving a full-employment, noninflationary level of total output Copyright McGraw-Hill/Irwin, 2005 CONSOLIDATED BALANCE SHEET OF THE FEDERAL RESERVE BANKS Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 3 Next Slide ASSETS • Securities • Loans to Commercial Banks LIABILITIES • Reserves of Commercial Banks • Treasury Deposits • Federal Reserve Notes Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 4 Next Slide Open-Market Operations Buying Securities From commercial banks... • Bank gives up securities • FED pays bank • Banks have increased reserves From the public... • Public gives up securities • Public deposits check in bank • Banks have increased reserves Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 5 Next Slide Open-Market Operations Selling Securities To commercial banks... • FED gives up securities • Bank pays for securities • Banks have decreased reserves To the public... • FED gives up securities • Public pays by check from bank • Banks have decreased reserves Copyright McGraw-Hill/Irwin, 2005 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level FEDERAL RESERVE PURCHASE OF BONDS Purchase of a $1000 bond from a bank... New reserves $800 Excess Reserves $200 Required reserves Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy $4000 Bank System Lending Key Terms Previous Slide End Show 15 - 6 $1000 Initial Deposit Next Slide Total Increase in Money Supply ($5000) Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 7 Next Slide Open-Market Operations The Reserve Ratio Raising the Reserve Ratio • Banks must hold more reserves • Banks decrease lending • Money supply decreases Lowering the Reserve Ratio • Banks may hold less reserves • Banks increase lending • Money supply increases Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 8 Next Slide Open-Market Operations The Reserve Ratio The Discount Rate Easy Money Policy • Buy Securities • Decrease Reserve Ratio • Lower Discount Rate Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 9 Next Slide Open-Market Operations The Reserve Ratio The Discount Rate Easy Money Policy Tight Money Policy • Sell Securities • Increase Reserve Ratio • Raise Discount Rate Copyright McGraw-Hill/Irwin, 2005 TOOLS OF MONETARY POLICY Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 10 Next Slide Open-Market Operations The Reserve Ratio The Discount Rate Discuss relative Easy Money Policy importance Tight Money Policy each control •of Sell Securities • Increase Reserve Ratio • Raise Discount Rate Copyright McGraw-Hill/Irwin, 2005 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 11 Next Slide MONETARY POLICY, REAL GDP, AND THE PRICE LEVEL Cause-Effect Chain • Money supply impacts interest rates • Interest rates affect investment • Investment is a component of AD • Equilibrium GDP is changed Copyright McGraw-Hill/Irwin, 2005 MONETARY POLICY AND EQUILIBRIUM GDP Sm1 Sm2 Sm3 Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Real rate of interest, i Goals of Monetary Policy Monetary Policy and Equilibrium GDP 10 10 8 8 6 6 Dm 0 Monetary Policy in Action Quantity of money demanded and supplied AS Key Terms Previous Slide End Show 15 - 12 Next Slide Price level Problems and Complications Monetary Policy and the International Economy Investment Demand P3 P2 P1 AD3(I=$25) AD2(I=$20) AD1(I=$15) Real domestic output, GDP Copyright McGraw-Hill/Irwin, 2005 0 Amount of investment, i If the Money Supply Increases to Stimulate the Economy… Interest Rate Decreases Investment Increases AD & GDP Increases with slight inflation Increasing money supply continues the growth – but, watch Price Level. MONETARY POLICY AND EQUILIBRIUM GDP Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 13 Next Slide Money Market •Investment •Equilibrium GDP Effects of an easy money policy Effects of a tight money policy Copyright McGraw-Hill/Irwin, 2005 MONETARY POLICY IN ACTION Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 14 Next Slide Strengths of monetary policy • Speed and flexibility • Isolation from political pressure Focus on the Federal Funds Rate The Federal Funds Rate The Prime Interest Rate Recent Monetary Policy Copyright McGraw-Hill/Irwin, 2005 Problems and Complications Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Lags Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Changes in Velocity Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 15 Next Slide Cyclical Asymmetry “Artful Management” or “Inflation Targeting” Copyright McGraw-Hill/Irwin, 2005 Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 16 MONETARY POLICY AND THE INTERNATIONAL ECONOMY • Net export effect • Macro stability and the trade balance • The “Big Picture” Next Slide Copyright McGraw-Hill/Irwin, 2005 monetary policy open-market operations reserve ratio discount rate easy money policy tight money policy Federal funds rate prime interest rate velocity of money cyclical asymmetry inflation targeting Copyright McGraw-Hill/Irwin, 2005 BACK END Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Extending the Analysis of Aggregate Supply Tools of Monetary Policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Monetary Policy in Action Next Chapter 16 Problems and Complications Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 18 Next Slide Copyright McGraw-Hill/Irwin, 2005
