Monetary Policy: Regulating Money Supply

Transcription

1 Monetary Policy: Regulating Money Supply

2 Review Quiz Trade Quiz #1: What are the two conflicting responsibilities of the Federal Reserve? Maximizing GDP & Employment while at the same time keeping inflation low

3 Review Quiz #2: What are two ways the Fed has some political independence when it comes to making their decisions? 14-year term of office Don t rely on money from Congress to keep running

4 Review Quiz #e: How many members of the Fed Board of Governors are there? 7

5 Review Quiz #4: How many District Branches of the Federal Reserve system are there? 12

6 Review Quiz Trade Quiz #5: What is the discount rate? The interest rate that the Federal Reserve charges on direct loans to the 12 District Banks

7 Review Quiz Trade Quiz #6: Who is on the Federal Open Market Committee (FOMC? The 7 members of the Board of Governors and 5 of the presidents of the District Banks

8 Review Quiz Trade Quiz #7: What important decisions does the FOMC make? What the FFR should be and how much money there should be in the economy?

9 Federal Reserve Structure Meets Federal 8 times Reserve a year to vote on Monetary Board Policy of Governors (7 members) Ben Bernanke Chairman Discount Rate=Interest rate that the Fed lends money directly to District Banks (rarely used) Federal Open Market Committee= 7 Governors + 5 District Bank Presidents meets 8 times per year SF Fed Building Market Street 12 District Federal Reserve Banks Boston San Francisco New York Atlanta Chicago Dallas, etc. Federal Funds Rate = Interest rate that the 12 District banks charge Each other on overnight loans Member Banks All national banks Some state banks

10 The Money Market Interest Rate (FFR) The Money Market S-Money Supply of Money is fixed by the Fed Fed controls money supply through monetary policy D-Money Demand for money is downward sloping as interest rates more $ is demanded Qty $ Modern-day economies are almost entirely run on CREDIT it s all about borrowing CONSTANTLY

11 2 Types of Monetary Policy LOOSE Monetary Policy (increasing the money supply) TIGHT Monetary policy (decreasing the money supply)

12 Two Tools of Monetary Policy 1. Discount Rate Changes Changing the interest rate at which District Banks borrow directly from the Fed

13 Two Tools of Monetary Policy 2. Open Market Operations Federal Reserve action to buy or sell Treasury bonds -- This changes the money supply, which shifts the Federal Funds Rate *Demonstration

14 Loose (aka Expansionary) Monetary Policy First, the Fed lowers the discount rate (i.e. 3% to 2%) Next, the Fed uses Open Market Operations to increase money supply --the Fed Buys government bonds from anyone selling them Interest Rate (FFR) MS 1 MS 2 Price Level AS 1 FFR FFR MD Affects ADpeople borrow & spend more AD1 AD 2 Qty of $ Real GDP

15 Important Fact: Time Lag FYI: Both Fiscal Policy (6-12 months) and Monetary Policy (12-24 months) have a time lag Translation: they do not have immediate effect

16 Tight (aka Contractionary)Monetary Policy First, the Fed raises the discount rate (i.e. 4.5% to 5.0%) Next, the Fed uses Open Market Operations to decrease money supply --the Fed Sells government bonds to willing investors Interest Rate (FFR) MS 2 MS 1 Price Level AS 1 FFR FFR MD Affects ADpeople borrow & spend less AD2 AD1 Qty of $ Real GDP

17 Economic Issue 1. Inflation rises to 10% Policy Type (Moderately Loose, Aggressively Loose, Moderately Tight, Aggressively Tight, or Take No Action) Aggressively Tight What action would the Fed take regarding Discount Rate (increase or decrease) Increase Discount Rate What would the Fed want to happed to the Federal Funds Rate (increase or decrease) Increase FFR What change in the Money Supply would be needed to bring about the desired change in FFR (increase or decrease) Decrease Money Supply What action in Open Market Operations would be needed to bring about the desired change in Money Supply (Buy or Sell Treasury Bills) Sell T-Bills 2. GDP growth is at 0.9%; the inflation rate is 1.8% Moderately Loose Decrease Discount Rate Decrease FFR Increase Money Supply Buy T-Bills 3. GDP growth rate is 2.1% and the inflation rate is 3.5% 4. Consumer confidence is falling; retail sales very weak; unemployment at 8.1% None OR Moderately Tight Aggressively Loose None OR Increase Discount Rate Decrease Discount Rate None OR Increase FFR Decrease FFR None OR Decrease Money Supply Increase Money Supply None OR Sell T-Bills Buy T-Bills 5. GDP growth is at 4.2%; inflation is at 3.6% Moderately Tight Increase Discount Rate Increase FFR Decrease Money Supply Sell T-Bills

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19 News Clips c31db8966b68 ***(4:29) good clip when Fed was considered cutting FFR from 1.5% (roundtable on FFR increase to 4.75%) (7:40) %20suze%20orman&rls=com.microsoft:*&oe=UTF-8&startIndex=&start Page=1&um=1&ie=UTF-8&sa=N&hl=en&tab=wv# (Suze Orman on FFR) (4:32) ***(first 45 seconds of 2 minute clip)

20 Economic Issue Policy Type (Moderately Loose, Aggressively Loose, Moderately Tight, Aggressively Tight, or Take No Action) Action on Open Market Operations (Buy or Sell Treasury Bills Effect on the Money Supply (increase or decrease) Effect on Federal Funds Rate (increase or decrease 1. Inflation rises to 10% Aggressive Contractionary Sell T-Bills Decrease Money Supply Increases FFR 2. GDP growth is at 4.2%; inflation is at 3.6% Moderate Contractionary Sell T-Bills Decrease Money Supply Increases FFR 3. GDP growth is 2.1% and the inflation rate is 3.5% Take no action OR Mod. Contractionary None OR Sell T-bills None OR Decrease MS None OR FFR 4. Consumer confidence is falling; retail sales very weak; unemployment at 8.1% Aggressive Expansionary Buy T-Bills Increase Money Supply Decreases FFR 5. GDP growth is at 0.9%; inflation rate is 1.8% Moderate Expansionary Buy T-Bills Increase Money Supply Decreases FFR

21 Monetary POLICY Monetary Policy will shift AD curve Price Level AS 1 Economy in recession Loose monetary policy needed AD 1 AD 2 Buys Securities & lowers discount rate Real GDP Money becomes cheaper; Interest rates go down AD shifts right

22 Economic Situation: GDP growth at +5.0%, Inflation rising, Unemployment 3% Loose or Tight Monetary policy needed? Solution: Tight Monetary Policy Interest Rate MS 2 MS 1 Affects AD Price Level AS 1 i i AD 1 MD AD2 End Result: Lower GDP & less inflation! Qty of $ Real GDP

23 Situation: GDP growth at -2.0%, Unemployment 9% Loose or Tight Monetary policy needed? Loose Monetary Policy Interest Rate MS 1 MS 2 Price Level AS 1 Affects AD i i MD AD1 AD2 Qty of $ Real GDP

24 Loose Monetary Policy 1. Fed LOWERS Discount Rate 2. Open-Market Operations Interest Rate BUYS Fed Securities MS 1 MS 2 Price Level AS 1 i i MD Affects AD AD1 AD 2 Qty of $ Real GDP

25 Tight Monetary Policy RAISES 1. Fed Discount Rate 2. Open-Market Operations Fed SELLS Securities Nominal Interest Rate i 2 MS i MS 1 MD Price Level Affects AD AS 1 AD2 AD1 Qty of $ Real GDP