Title: The Federal Reserve and Monetary Policy
1The Federal Reserve and Monetary Policy
2The Federal Reserve System
- The central bank of the US is the Federal Reserve
System, usually called the Fed.
- The Bank for Banks.
- Twelve Districts.
3The Structure of the Fed
4The Feds Policy Tools
- The Fed controls the amount of money in
circulation in the United States by using three
tools
- 1. Required reserve ratios (or Reserve
Requirement)
- 2. Discount rate
- 3. Open market operations
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6The Feds Balance Sheet, December 1998(page 335)
Assets Liabilities (billions of dollars) (billi
ons of dollars)
- Gold and foreign exchange 65 Federal Reserve
notes 481
- U.S. government securities 463 Banks
deposits 27
- Loans to banks 0 Other liabilities (net) 20
- Total assets 528 Total liabilities (net) 528
7Monetary Base
- The monetary base is total currency in
circulation plus banks reserve deposits at the
Fed.
8The Money Multiplier
- The money multiplier is the amount by which a
change in the monetary base will change in the
quantity of money.
- M mm B
9The Impact of Currency
- An increase in currency held outside banks is
called a currency drain.
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11The Demand for Money
- There is no limit to the amount of income we
would like to receive.
- There is, however, a limit to how much money we
want to hold.
- The amount of money we hold is a stock of
purchasing power.
12Motive to hold Money
- Precautionary demand
- Transaction demand
- Speculative demand
13The Influences onMoney Holding
- The quantity of money people choose to hold
depends on four main factors
- 1. The price level
- 2. The interest rate
- 3. Real GDP
- 4. Financial innovation
14The Demand for Money Curve
Effect of an increase in the interest rate
6
Interest rate (percent per year)
5
Effect of a decrease in the interest rate
4
MD
2.9
3.0
3.1
Real money (trillions of 1992 dollars)
15Changes in the Demand Curve for Real Money
Effect of increase in real GDP
6
Interest rate (percent per year)
5
MD2
4
Effect of decrease in real GDP or financial inno
vation
MD0
MD1
2.9
3.0
3.1
Real money (trillions of 1992 dollars)
16The Demand for Moneyin the United states
17The Demand for Moneyin the United states
18Money Market Equilibrium
MS
6
Excess supply of money. People buy bonds and i
nterest
rate falls
Interest rate (percent per year)
5
4
Excess demand for money. People sell bonds and
interest
rate rises.
MD
2.9
3.0
3.1
Real money (trillions of 1992 dollars)
19Shifts in money supply and ? in interest rate.
MS0
6
Interest rate (percent per year)
5
4
MD
2.9
3.0
3.2
2.8
3.1
Real money (trillions of 1992 dollars)
20Monetary Policy
21From an open market operation to an impact on AD.
- 1. The FED Buys a bond.
- 2. Bond prices go up and interest rates go
down.
- 3. This increases reserves and the money supply.
22Direct Effect
- People spend the money on securities or on goods
and services.
- This increases I or C.
23Indirect Effect
- The lower interest rates makes credit cheaper.
Increase in I.
- It lowers the price of the dollar on the foreign
exchange market. Increase in X.
24The Ripple Effects of Monetary Policy
25Monetary Policy
- Does it work?
- Most short-term interest rates move together.
- Short-term interest rates moved in the opposite
direction from M2 until 1990.
26Money and Interest Rates
27Cause and Effect
- M2 and interest rates usually move in opposite
directions .
- This does not tell us which is the cause and
which is the effect.
- Do the Feds own actions cause interest rates to
change?
28How long will it take?
- The lags may be up to a year an a half.
- Does this make Monetary Policy effective?
29What effect does the anticipation of a policy
change have?
30Profiting by Predicting the Fed
- Some open market operations are designed to
change interest rates.
- Predicting Interest Rates
- The effect of anticipation
31The History of the FED
- Paul Volckers Fed
- Alan Greenspans Fed
- The Fed Tries for a Soft Landing
32Interest Rates andReal GDP Growth
33Did you learn?
- What is the FED and what is the FOMC?
- What is the base and how is it controlled?
- How the interest rate changes the demand for
money?
- How the short-run interest rates are determined
in the "money market."
- How monetary policy "works" and how effective is
it?
- What were the goals of the Volker FED, and what
are the goals of Greenspan FED?