Chapter 18. Conduct of Monetary Policy Goals of monetary policy Using targets A History of monetary...
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Transcript of Chapter 18. Conduct of Monetary Policy Goals of monetary policy Using targets A History of monetary...
Chapter 18. Conduct of Monetary Chapter 18. Conduct of Monetary PolicyPolicy
Chapter 18. Conduct of Monetary Chapter 18. Conduct of Monetary PolicyPolicy
• Goals of monetary policy
• Using targets
• A History of monetary policy
• Policy Rules
• Goals of monetary policy
• Using targets
• A History of monetary policy
• Policy Rules
I. GoalsI. GoalsI. GoalsI. Goals
• desirable goals for the economy
• Fed uses monetary policy to achieve these goals• directly control tools,
to influence goals
• desirable goals for the economy
• Fed uses monetary policy to achieve these goals• directly control tools,
to influence goals
High employmentHigh employmentHigh employmentHigh employment
• i.e., low unemployment
• federal government has a commitment to full employment
• goal: natural rate of unemployment• about 4-5%• today: 5.1% (3/05)• 7.7% in Oswego Co.
• i.e., low unemployment
• federal government has a commitment to full employment
• goal: natural rate of unemployment• about 4-5%• today: 5.1% (3/05)• 7.7% in Oswego Co.
Economic GrowthEconomic GrowthEconomic GrowthEconomic Growth
• annual % change in real GDP
• U.S. long run average -- 3%
• 2004 GDP growth 4.4%
• annual % change in real GDP
• U.S. long run average -- 3%
• 2004 GDP growth 4.4%
Price stabilityPrice stabilityPrice stabilityPrice stability
• i.e., low inflation• annual % change in CPI
• primary goal of Fed since 1980s
• how high is too high?• over 4%• goal: 2% or less
• 2004
• i.e., low inflation• annual % change in CPI
• primary goal of Fed since 1980s
• how high is too high?• over 4%• goal: 2% or less
• 2004
tradeofftradeofftradeofftradeoff
• between price stability & economic growth• controlling inflation can mean
slowing down economic growth
• between price stability & economic growth• controlling inflation can mean
slowing down economic growth
Financial Market StabilityFinancial Market StabilityFinancial Market StabilityFinancial Market Stability
• stability of financial institutions
• stability of interest rates
• stability of exchange rates
• Fed stabilized markets• October 1987• Summer 1998• September 2001
• stability of financial institutions
• stability of interest rates
• stability of exchange rates
• Fed stabilized markets• October 1987• Summer 1998• September 2001
II. Using targetsII. Using targetsII. Using targetsII. Using targets
• Fed directly controls tools (like OMO), not goals
• it can take a year for tools to impact the goals• how to gauge progress in
between?
• Fed directly controls tools (like OMO), not goals
• it can take a year for tools to impact the goals• how to gauge progress in
between?
TargetsTargetsTargetsTargets
• related to tools and goals
• used by Fed to judge if they are on track
• related to tools and goals
• used by Fed to judge if they are on track
goalintermediatetarget
operatingtarget
tool(OMO)
operating targetsoperating targetsoperating targetsoperating targets
• respond immediately to changes in the tools
• examples• bank reserves• FF rate• Tbill rate
• respond immediately to changes in the tools
• examples• bank reserves• FF rate• Tbill rate
intermediate targetsintermediate targetsintermediate targetsintermediate targets
• affected by operating target
• closely associated with goals
• examples• M1, M2 or M3• prime rate• Tnote or Tbond yields
• affected by operating target
• closely associated with goals
• examples• M1, M2 or M3• prime rate• Tnote or Tbond yields
exampleexampleexampleexample
• Fed wants 5% nominal GDP growth• intermediate target 4% M2 growth• operating target 3% MB growth• conduct open market purchases to
increase MB by 3%
• Fed wants 5% nominal GDP growth• intermediate target 4% M2 growth• operating target 3% MB growth• conduct open market purchases to
increase MB by 3%
effective targetseffective targetseffective targetseffective targets
• frequently and accurately measured
• controllable by the Fed
• predictably related to goals
• frequently and accurately measured
• controllable by the Fed
• predictably related to goals
2 types of targets2 types of targets2 types of targets2 types of targets
• monetary targets• reserves, MB• M1, M2, or M3
• interest rate targets• FF rate • other short or medium-term rates
• monetary targets• reserves, MB• M1, M2, or M3
• interest rate targets• FF rate • other short or medium-term rates
target tradeofftarget tradeofftarget tradeofftarget tradeoff
• Fed can target money supply OR interest rates
• NOT BOTH!
• why?
• Fed can target money supply OR interest rates
• NOT BOTH!
• why?
• suppose Fed targets M* for MS:• suppose Fed targets M* for MS:
M
i MS
M*
MD’’
i’’
• but as MD fluctuates, i will change:• but as MD fluctuates, i will change:
M
i MS
M*
MD’’
i’’ MD’’’
i’’’
MD’
i’
• so if target M*, lose control of i• so if target M*, lose control of i
M
i MS
M*
MD’’
i’’ MD’’’
i’’’
MD’
i’
• suppose Fed targets i*• suppose Fed targets i*
M
i
MD’’
i*
MS
M’’
• but as MD fluctuates, Fed must shift MS to maintain i*• but as MD fluctuates, Fed must shift MS to maintain i*
M
i MS
M’’
MD’’
i* MD’’’
MD’
M’
MS’
M’’’
MS’’’
• Fed targets i*, lose control of M• Fed targets i*, lose control of M
M
i MS
M’’
MD’’
i* MD’’’
MD’
M’
MS’
M’’’
MS’’’
TargetsTargetsTargetsTargets
• If Fed targets MS, loses control of interest rates
• If Fed targets interest rates, loses control of MS
• If Fed targets MS, loses control of interest rates
• If Fed targets interest rates, loses control of MS
III. A History of Fed PolicyIII. A History of Fed PolicyIII. A History of Fed PolicyIII. A History of Fed Policy
• Early years (1913-1929)
• The Great Depression
• WWII
• 1950s, 60s
• 1970s
• 1979-82
• 1982-92
• 1992-present
• Early years (1913-1929)
• The Great Depression
• WWII
• 1950s, 60s
• 1970s
• 1979-82
• 1982-92
• 1992-present
The Early YearsThe Early YearsThe Early YearsThe Early Years
• 1913-1929
• main tool: discount loans
• real bill doctrine• use discount loans for production
loans• result: inflation
• 1913-1929
• main tool: discount loans
• real bill doctrine• use discount loans for production
loans• result: inflation
• cut back on discount loans• recession/deflation 1920-21
• discovered OMO in 1920s• make up for lost revenue from
discount loans by holding Treasuries
• cut back on discount loans• recession/deflation 1920-21
• discovered OMO in 1920s• make up for lost revenue from
discount loans by holding Treasuries
The Great DepressionThe Great DepressionThe Great DepressionThe Great Depression
• Fed failed to act as lender of last resort and prevent bank failures 1930-33
• why?• initial failures were small banks• Fed failed to recognize domino
effect on larger banks & economy
• Fed failed to act as lender of last resort and prevent bank failures 1930-33
• why?• initial failures were small banks• Fed failed to recognize domino
effect on larger banks & economy
• mid 1930s• recovering from GD but• Fed increases reserve requirement
-- recession 1937-38
• mid 1930s• recovering from GD but• Fed increases reserve requirement
-- recession 1937-38
1942-511942-511942-511942-51
• during WWII Fed targeted Tbill rate• kept rate low to help finance war• large MS growth
-- but price controls kept inflation low
• post WWII inflation• Fed abandoned Tbill rate target
• during WWII Fed targeted Tbill rate• kept rate low to help finance war• large MS growth
-- but price controls kept inflation low
• post WWII inflation• Fed abandoned Tbill rate target
1950s - 1960s1950s - 1960s1950s - 1960s1950s - 1960s
• targeting “money market conditions”• short term interest rates• free reserves
= excess reserves - discount loans
• result: procyclical monetary policy• MS rose during expansions,
fell during recessions.
• targeting “money market conditions”• short term interest rates• free reserves
= excess reserves - discount loans
• result: procyclical monetary policy• MS rose during expansions,
fell during recessions.
Why?Why?Why?Why?
• chain reaction:• chain reaction:
economicexpansion
income rises
MD rises
interest rate rise
ER declineDL riseFR decline
increaseMS
Fed increasesMB
• procyclical money growth is not a good thing• rapid MS growth in expansion
leads to inflation• slow MS growth in recession
makes it worse
• procyclical money growth is not a good thing• rapid MS growth in expansion
leads to inflation• slow MS growth in recession
makes it worse
• MS should be countercyclical• “lean against the wind”• keep inflation under control• help prevent or end recessions
• MS should be countercyclical• “lean against the wind”• keep inflation under control• help prevent or end recessions
1970s1970s1970s1970s
• Fed announces target of money aggregates (M1, M2)• but FOMC targets both aggregates
& FF rate
-- cannot do both• Fed really targeting FF rate,
& MS growth still procyclical
• Fed announces target of money aggregates (M1, M2)• but FOMC targets both aggregates
& FF rate
-- cannot do both• Fed really targeting FF rate,
& MS growth still procyclical
• Fed criticized in 1970s for failure to control inflation• energy crisis of 1973-74 did not
help
• Fed criticized in 1970s for failure to control inflation• energy crisis of 1973-74 did not
help
1979-821979-821979-821979-82
• inflation over 10% by 1979
• Paul Volcker
• target nonborrowed reserves• reserves - discount loans• slow MS growth to bring down
inflation
• large interest rate fluctuations
• inflation over 10% by 1979
• Paul Volcker
• target nonborrowed reserves• reserves - discount loans• slow MS growth to bring down
inflation
• large interest rate fluctuations
• recession 1981-82• “Volcker recession”
• inflation below 4% by 1982
• signaled change at Fed• price stability # 1 goal• fight inflation inflation before it
gets to be a problem
• recession 1981-82• “Volcker recession”
• inflation below 4% by 1982
• signaled change at Fed• price stability # 1 goal• fight inflation inflation before it
gets to be a problem
1982-921982-921982-921982-92
• targeting “borrowed reserves” or interest rates• procyclical policy
• stopped setting targets for M1, M2
• Alan Greenspan 1987• intervened 1987 crash• slow to act for 90-91 recession
• targeting “borrowed reserves” or interest rates• procyclical policy
• stopped setting targets for M1, M2
• Alan Greenspan 1987• intervened 1987 crash• slow to act for 90-91 recession
• exchange rate markets• $ too high• Fed, with other central banks
intervened to bring $ down
• exchange rate markets• $ too high• Fed, with other central banks
intervened to bring $ down
1992 - present1992 - present1992 - present1992 - present
• 1990s longest expansion in U.S. history
• announced FF rate target 1994
• 1994-95 “soft landing”• prevent rising inflation by
increasing FF rate
• 1990s longest expansion in U.S. history
• announced FF rate target 1994
• 1994-95 “soft landing”• prevent rising inflation by
increasing FF rate
• 1994 exchange rates• this time Fed intervened for a $
that was too low
• 1998 Russian debt/ Asia crisis• lower FF rate to keep U.S.
economy expanding
• 1994 exchange rates• this time Fed intervened for a $
that was too low
• 1998 Russian debt/ Asia crisis• lower FF rate to keep U.S.
economy expanding
• 1999-2000• Fed hiked FF rate to prevent inflation
• 2000-2001• Fed reversed FF rate hikes as economy
slowed
• 2002-present• FF rate targets have slowly risen• but not LT rates
• 1999-2000• Fed hiked FF rate to prevent inflation
• 2000-2001• Fed reversed FF rate hikes as economy
slowed
• 2002-present• FF rate targets have slowly risen• but not LT rates
IV. Policy RulesIV. Policy RulesIV. Policy RulesIV. Policy Rules
• how to choose a target for monetary policy?
• how to respond to changing economic conditions?
• how to choose a target for monetary policy?
• how to respond to changing economic conditions?
The Taylor RuleThe Taylor RuleThe Taylor RuleThe Taylor Rule
• John Taylor
• equation• FF rate target based on
-- current inflation
-- inflation target
-- gap between actual GDP &
full employment GDP
• John Taylor
• equation• FF rate target based on
-- current inflation
-- inflation target
-- gap between actual GDP &
full employment GDP
Taylor ruleTaylor ruleTaylor ruleTaylor rule
• Fed responds to both• price stability• business cycle
• Fed responds to both• price stability• business cycle
FFrate
= inflation + LR FF rate
+ .5(inflation gap)
+ .5(output gap)
NAIRUNAIRUNAIRUNAIRU
• nonaccelerating inflation rate of unemployment• lowest unemployment rate
possible without triggering inflation
• possible goal for Fed
• nonaccelerating inflation rate of unemployment• lowest unemployment rate
possible without triggering inflation
• possible goal for Fed
• problem: what is NAIRU?• prior to 1995 may would have said
5%• but unemployment below 4% in
late 1990s without causing inflation
• problem: what is NAIRU?• prior to 1995 may would have said
5%• but unemployment below 4% in
late 1990s without causing inflation