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 Monetary Policy and Equilibrium GDP THE FEDERAL RESERVE AND THE BANKING SYSTEM Open Market Committee Board of Governors Advisory Councils 12 Federal Reserve Banks Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Commercial Banks Thrift Institutions (Savings & loan associations, mutual savings banks, credit unions) Key Terms Previous Slide End Show 15 - 1 Next Slide The Public (Households and businesses) Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate FEDERAL RESERVE BANK OF THE U.S. Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 2 Next Slide Copyright McGraw-Hill/Irwin, 2002 Fed Functions- Money Supply 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 3 Next Slide • 1. Issuing Currency—Federal Reserve Notes—paper currency—issued by districtbanks. Money identifies what district it came from on upper left of front of bill. • 2. Setting Reserve Requirements • 3. Lending Money to banks/thrifts • 4. Provides for check collection • 5. Acts as fiscal agent—gov’ts bank! Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Fed Functions-Money Supply • 6. Supervising banks • 7. Controlling Money Supply – -To stabilize – -To influence expansion/contraction of economy. Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 4 Next Slide Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 5 Next Slide …to assist the economy in achieving a full-employment, noninflationary level of total output Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 6 Next Slide ASSETS • Securities • Loans to Commercial Banks LIABILITIES • Reserves of Commercial Banks • Treasury Deposits • Federal Reserve Notes Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 7 Next Slide Open Market Operations Buying Securities From commercial banks... • Bank gives up securities • FED pays bank • Banks have increased reserves From individuals... • Individual gives up securities • Individual deposits check in bank • Banks have increased reserves Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy $4000 Bank System Lending Key Terms Previous Slide End Show 15 - 8 $1000 Initial Deposit Next Slide Total Increase in Money Supply ($5000) Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 9 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, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate 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 Easy Money Policy • Buy Securities • Decrease Reserve Ratio • Lower Discount Rate Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 11 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, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms ative ce trol Previous Slide End Show 15 - 12 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, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 13 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, 2002 MONETARY POLICY AND EQUILIBRIUM GDP Sm1 S m2 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 Effectiveness of Monetary Policy Quantity of money demanded and supplied Targeting the Federal Funds Rate Key Terms Previous Slide End Show 15 - 14 Next Slide AS Price level Monetary Policy and the International Economy Investment Demand P2 P1 0 Amount of investment, i Money Supply Increases Interest Rate Decreases Investment Increases AD1 AD2 Real domestic output, GDP Copyright McGraw-Hill/Irwin, 2002 AD & GDP Increases with slight inflation s t MONETARY POLICY AND EQUILIBRIUM GDP Sm1 S S m2 m3 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 Effectiveness of Monetary Policy Quantity of money demanded and supplied Targeting the Federal Funds Rate Key Terms Previous Slide End Show 15 - 15 Next Slide AS Price level Monetary Policy and the International Economy Investment Demand P3 P2 P1 0 Amount of investment, i More Money Supply Lower Interest Rates More Investment AD1 AD2 AD3 Real domestic output, GDP Copyright McGraw-Hill/Irwin, 2002 Still higher AD & GDP with significant inflation su Goals of Monetary Policy Consolidated Balance Sheet of the Federal Reserve Banks Tools of Monetary Policy MONETARY POLICY, REAL GDP AND THE PRICE LEVEL Effects of an easy money policy Federal Reserve Purchase of Bonds Monetary Policy, Real GDP, and the Price Level Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Effects of a tight money policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 16 Next Slide Monetary policy & aggregate supply Copyright McGraw-Hill/Irwin, 2002 EFFECTIVENESS 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 17 Next Slide Strengths of monetary policy • Speed and flexibility • Isolation from political pressure • Successes in the 1980s & 1990s Shortcomings and problems • Less control? • Changes in velocity • Cyclical asymmetry Copyright McGraw-Hill/Irwin, 2002 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 TARGETING THE FEDERAL FUNDS RATE Generalized Interest Rate Changes Monetary Policy and Equilibrium GDP Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 18 Next Slide Money Supply Impact The Federal Funds Rate The Prime Interest Rate Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 19 Next Slide MONETARY POLICY AND THE INTERNATIONAL ECONOMY • Net export effect • Macro stability and the trade balance • The “Big Picture” Chapter Conclusions Copyright McGraw-Hill/Irwin, 2002 Net Export Effect 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 Effectiveness of Monetary Policy Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 20 Next Slide • FED Contractionary: Raise interest rate: – – – – Dollar goes up Exports fall Imports rise Therefore: Negative Net Export Effect • FED Expansionary: Lower interest rate: – – – – – Dollar goes down Exports rise Imports fall GDP increases Positive net export effect Copyright McGraw-Hill/Irwin, 2002 monetary policy open-market committee reserve ratio discount rate easy money policy tight money policy velocity of money cyclical asymmetry Federal funds rate prime interest rate Copyright McGraw-Hill/Irwin, 2002 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 Effectiveness of Monetary Policy Next Chapter 16 Targeting the Federal Funds Rate Monetary Policy and the International Economy Key Terms Previous Slide End Show 15 - 22 Next Slide Copyright McGraw-Hill/Irwin, 2002
