Activity 40 Monetary Policy. 1. What is monetary policy?

25
Activity 40 Monetary Policy

Transcript of Activity 40 Monetary Policy. 1. What is monetary policy?

Page 1: Activity 40 Monetary Policy. 1. What is monetary policy?

Activity 40

Monetary Policy

Page 2: Activity 40 Monetary Policy. 1. What is monetary policy?

1. What is monetary policy?

Page 3: Activity 40 Monetary Policy. 1. What is monetary policy?

• 1. What is monetary policy?

• Central bank activities to– Promote growth– Stabilize prices– Maximize employment– Moderate long-term

interest rates

• Actions by the Fed to increase or decrease the money supply, to influence the economy

Page 4: Activity 40 Monetary Policy. 1. What is monetary policy?

2. From 1998 to 2002, what was the dominant focus of monetary policy and

why?

Page 5: Activity 40 Monetary Policy. 1. What is monetary policy?

• 2. From 1998 to 2002, what was the dominant focus of monetary policy and why?

• From 1998 to 2001, the Fed wanted to slow growth to prevent inflation

• From 2001on the Fed wanted to stimulate growth without stimulating inflation

Page 6: Activity 40 Monetary Policy. 1. What is monetary policy?

3. Explain why the money supply and short-term interest rates are inversely

related.

Page 7: Activity 40 Monetary Policy. 1. What is monetary policy?

• 3. Explain why the money supply and short-term interest rates are inversely related.

• Money supply is money supply, regardless of the interest rate; it is perfectly inelastic because it is controlled by the Fed.– However changes in

the money supply and short-term (nominal interest rates) are inversely related

• When the Fed buys securities (to increase the money supply) banks have more checkable deposits and therefore more reserves. Banks lower rates to entice more customers– Easy money policy lowers the

nominal interest rate• When the Fed sells securities

(to decrease the money supply) banks have fewer checkable deposits and therefore fewer reserves. Banks raise rates because they have fewer customers– Tight money policy raises the

nominal interest rate

Page 8: Activity 40 Monetary Policy. 1. What is monetary policy?

4. What are some reasons for lags and imperfections in data used by central banks?

Page 9: Activity 40 Monetary Policy. 1. What is monetary policy?

• 4. What are some reasons for lags and imperfections in data used by central banks?

• Financial institutions report at specified times (ie; quarterly to stockholders) and this may not be when the Fed may necessarily needs the information most.

• The central bank collects data from samples and extrapolates, errors can be in the data

Page 10: Activity 40 Monetary Policy. 1. What is monetary policy?

5. Why do many economists believe that central banks have more control over the

price level than over real output?

Page 11: Activity 40 Monetary Policy. 1. What is monetary policy?

• 5. Why do many economists believe that central banks have more control over the price level than over real output?

• Many believe real output is determined by the level of capital stock and worker productivity– Thus money affects

price level more than output

– The P in PQ rather than the Q

Page 12: Activity 40 Monetary Policy. 1. What is monetary policy?

6. What might cause velocity to change?

Page 13: Activity 40 Monetary Policy. 1. What is monetary policy?

• 6. What might cause velocity to change?

• Changes in how money is transferred

• Changes in interest rates– Higher interest rates

tends to increase velocity

• Changes in price level– Higher price level

tends to increase velocity

Page 14: Activity 40 Monetary Policy. 1. What is monetary policy?

7. If velocity were extremely volatile, why would this

complicate the job of making monetary policy?

Page 15: Activity 40 Monetary Policy. 1. What is monetary policy?

• 7. If velocity were extremely volatile, why would this complicate the job of making monetary policy?

• Change in Money supply affects price level in predictable ways if velocity is constant

• If velocity is volatile: a change in money supply may be too small (not helping) or too large (leading to inflation)

Page 16: Activity 40 Monetary Policy. 1. What is monetary policy?

8. What role does the money multiplier (deposit expansion

multiplier) play in enabling the Fed to conduct monetary policy?

Page 17: Activity 40 Monetary Policy. 1. What is monetary policy?

• 8. What role does the money multiplier (deposit expansion multiplier) play in enabling the Fed to conduct monetary policy?

• The multiplier (the reciprocal of the reserve requirement) times excess reserves,yields changes in the money supply

Page 18: Activity 40 Monetary Policy. 1. What is monetary policy?

9. What is the fed funds rate?

Page 19: Activity 40 Monetary Policy. 1. What is monetary policy?

• 9. What is the fed funds rate?

• The interest rates banks (financial institutions) lend to other banks for short term borrowing (overnight loans from their excess reserves at their Fed account to another’s)

Page 20: Activity 40 Monetary Policy. 1. What is monetary policy?

10. What happens to the fed funds rate if the Fed follows a contractionary (tight money)

policy?

Page 21: Activity 40 Monetary Policy. 1. What is monetary policy?

• 10. What happens to the fed funds rate if the Fed follows a contractionary (tight money) policy?

• The federal funds rate increases

Page 22: Activity 40 Monetary Policy. 1. What is monetary policy?

11. What happens to the fed funds rate if the Fed follows a expansionary (easy money)

policy?

Page 23: Activity 40 Monetary Policy. 1. What is monetary policy?

• 11. What happens to the fed funds rate if the Fed follows a expansionary (easy money) policy?

• The federal funds rate decreases

Page 24: Activity 40 Monetary Policy. 1. What is monetary policy?

12. Why do observers pay close attention to the federal funds

rate?

Page 25: Activity 40 Monetary Policy. 1. What is monetary policy?

• 12. Why do observers pay close attention to the federal funds rate?

• It is a leading indicator (early indicator) of monetary policy and – a forecast of the

direction for other interest rates and

– for Fed assessment of the direction of the economy