PRIN OF ECONOMICS
PRIN OF ECONOMICS ECON 203
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This 11 page Class Notes was uploaded by Miss Kristy Veum on Wednesday October 21, 2015. The Class Notes belongs to ECON 203 at Texas A&M University taught by Michael Nelson in Fall. Since its upload, it has received 27 views. For similar materials see /class/225828/econ-203-texas-a-m-university in Economcs at Texas A&M University.
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Date Created: 10/21/15
1212010 Monetary Policy 39 i it Recall that Monetary Policy is policy followed by the Fed using money supply and interest rates to pursue macroeconomic objectives The goals of monetary policy I Price Stability I High Employment I EconomicGrowth I Stability of financial markets and institutions 1212010 The Money Market The Fed uses two monetary policy targets in order to achieve its policy goals I Money Supply The money supply in the economy is controlled by I Money Demand A person s wealth can be held as stocks and bonds which earn a return or as money currency or checking account which earns zero return Cost of holding money It s the foregone return that you could ve earned if you held bonds as measured by 39 i I Ceteris paribus rising interest rates lead the public to demand Shifts in Mone Su MS If the Fed wants to shift the MS to the right it engages in If the Fed wants to shift the MS to the left it engages in Shifts in Money Demand MD What causes people to demand more money shift MD to the right I Tin Real GDP I T in Price Level 1212010 39 The Money Market Interest Rate i Quantity of Money M Interest Rate i MD1 Quantity of Money M 1212010 Interest Rate i MD Quantity of Money M 39 I How are interest rates determined Two models Loanable Funds Model and the Money Market Whytwo models Loanable Funds Model determines the Money Market determines the Note that the Fed s monetary policy target is the Federal Funds Rate which is the rate that banks charge each other for The Fed can indirectly lower this rate by pumping reserves into the banking system via open market purchases and vice versa Does the Federal Funds Rate matterto you orto businesses The Importance of the Federal Funds Rate Federal Funds Rate Targetin FIGURE 146 i January 1997 May 2007 Federal 3 7 6 i i i u u i i Jan Jan Jan Jan Jan Jan Jan Jan 1997 1998 1999 2000 2001 2002 2003 2004 Learning Objective 142 I Actual federal funds rate I Target lederai iunds ran i Jan Jan Jan 2005 2006 2007 Note that the Fed s actions affect a nominal interest rate Changes in this nominal rate however usually not always cause changes in real interest rates And rememberthat real interest rates are what affect Specifically if the Fed decreases interest rates it causes increases in I Consumption I Investment I Net Exports 1212010 How increases in money supply affect the AD Curve MS MD AD 39 Expansionary Monetary Policy Price Level LRAS SRASw Real GDP 1212010 1212010 39 7 r Contractionary Monetary Policy Price Level LRAS SRAs1 AD1 Real GDP Learningobiec ve 143 A Summary of How Monetary Policy Works Table 141 mar 1753 b A conlraclionary policy 39 J Stabilization Policy I If the economy is below fullemployment output the Fed should engage in expansionary policy I If the economy is above fullemployment output the Fed should engage in contractionary policy The above is termed stabilization policy because when practiced effectively it can dampen the business cycle and stabilize the economy The problem of time lags D Information Lags E Lags in the effect ofthe policy Real GDP Long run trend In Real GDP Time 1212010 Debates about Fed Targeting Currently the Fed targets interest rates Some led by Milton Friedman have argued that the Fed should instead target the Specifically these Monetarists argue that the Fed ought to replace monetary policy with a monetary growth rule For example the Fed should simply ensure that the money supply grows at a constant rate equal to In such a case the Fed would be unresponsive to changes in Note that the Fed cannot simultaneously target both the money supply and the interest rate 39 1 Money Target M 1 Interest Rate i MD Quantity of Money M 1212010 Interest Rate i Interest Rate Target 81 MD Quantity of Money M Another Tarqetinq Option Inflation Tarqetinq In this case the Fed would publicly declare an inflation rate target say 2 and conduct policy with this goal in min The Case for Fed lndegendence The Case Against Fed lndegendence 1212010 LeameObiec ve 145 The Case for Fed Independence l u 335123 9 W Spain FIGURE 1412 60 The More Independent 7 quotmy the Central Bank the 7 0 New Zeaalarm Lower the Inflatjoh Rate e o 39 5 D I A o 39 United States 3 a Swuzerland 7quot Germany 2 0 1 0 D 1 a 4 Inuax ol central bank Independence 1212010
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