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Chapter 32 Checkpoint

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Title: Chapter 32 Checkpoint Author: Robin Bade and Michael Parkin Last modified by: Compositor Created Date: 11/24/2000 5:02:06 PM Document presentation format – PowerPoint PPT presentation

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Title: Chapter 32 Checkpoint


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33
Monetary Policy
CHECKPOINTS
3
Checkpoint 33.1
Checkpoint 33.3
Checkpoint 33.2
Problem 1
Problem 1
Problem 1
Clicker version
Problem 2
Problem 2
Clicker version
Problem 2
Clicker version
Problem 3
Problem 3
Clicker version
Problem 3
Problem 4
Problem 4
Problem 4
In the news
4
CHECKPOINT 33.1
  • Practice Problem 1
  • What are the objectives of U.S. monetary policy?

5
CHECKPOINT 33.1
  • Solution
  • The objectives of U.S. monetary policy are to
    achieve stable prices (interpreted at a core
    inflation rate of 2 percent a year) and maximum
    employment (interpreted as full employment).

6
Study Plan Problem The objectives of U.S.
monetary policy are to achieve ___.
CHECKPOINT 33.1
  1. maximum employment, stable prices, and moderate
    long-term interest rates
  2. zero unemployment, predictable prices, and
    long-term interest rates that are lower than
    short-term interest rates
  3. zero unemployment, stable prices, and moderate
    long-term interest rates
  4. maximum employment, predictable prices, and
    short-term interest rates that are lower than
    long-term interest rates.

7
CHECKPOINT 33.1
  • Practice Problem 2
  • What is core inflation and how does it differ
    from total PCE inflation?

8
CHECKPOINT 33.1
  • Solution
  • Core inflation excludes the changes in the prices
    of food and fuel.
  • The total PCE inflation rate includes the changes
    in all consumer prices.
  • The core inflation rate fluctuates less than the
    total PCE inflation rate.

9
Study Plan Problem The core inflation rate is
the annual percentage change in the _____. The
core inflation rate fluctuates _____ than the
total PCE inflation rate.
CHECKPOINT 33.1
  1. Personal Consumption Expenditure deflator
    excluding the prices of food and fuel more
  2. Personal Consumption Expenditure deflator
    excluding the prices of food and fuel less
  3. Personal Consumption Expenditure deflator
    excluding the prices of food, fuel, and housing
    less
  4. GDP deflator more

10
CHECKPOINT 33.1
  • Practice Problem 3
  • What is the Feds monetary policy instrument and
    what influences the level at which the Fed sets
    it?

11
CHECKPOINT 33.1
  • Solution
  • The federal funds rate is the Feds monetary
    policy instrument .
  • The inflation rate and output gap are two
    variables that Fed tries to influence when it
    sets the federal funds rate.

12
Study Plan Problem What is the Feds monetary
policy instrument, and what influence the level
at which the Fed sets it?
CHECKPOINT 33.1
  1. monetary base nominal GDP and real GDP
  2. quantity of money the output gap and the
    inflation rate
  3. federal funds rate the output gap and the
    inflation rate
  4. core inflation rate the unemployment rate and
    the long-term interest rate
  5. federal funds rate the quantity of money and the
    monetary base

13
CHECKPOINT 33.1
  • Practice Problem 4
  • The current quantity of reserves supplied is 20
    billion.
  • The Fed wants to set the federal funds rate at 4
    percent a year.
  • Illustrate the target on the graph and show the
    supply of reserves that will achieve the target.
  • Does the Fed conduct an open market operation and
    if so, does it buy or sell securities?

The demand for bank reserves, RD.
14
CHECKPOINT 33.1
  • Solution
  • If the initial quantity of reserves supplied was
    20 billion, the federal funds rate must have
    been 5 percent a year at point A.
  • To set the federal funds rate at 4 percent a
    year, the Fed must conduct an open market
    purchase to increase the supply of reserves to
    RS.
  • The equilibrium federal funds rate equals the
    target of 4 percent a year.

15
CHECKPOINT 33.1
  • In the news
  • Can Fed target jobless rate? Bernanke hints at
    new policy
  • With little notice, Bernanke seemed to buck
    conventional wisdom and suggest that the Fed can,
    and should, try to influence long-term
    unemployment.
  • Source CNCB, October 10, 2011
  • Explain whether trying to influence the long-term
    unemployment rate is consistent with the Feds
    monetary policy objectives.

16
CHECKPOINT 33.1
  • Solution
  • The objectives of monetary policy are maximum
    employment and stable prices.
  • The maximum-employment goal means keeping the
    economy as close as possible to potential GDP.
  • The stable-prices goal means keeping the
    inflation rate low.
  • In 2011, the inflation rate was low but the
    unemployment rate and the output gap were high.

17
CHECKPOINT 33.1
  • By focusing on the output gap, the Fed was
    seeking to re-establish maximum employment.
  • The Fed believed that inflation would remain low,
    so its focus was consistent with its monetary
    policy objectives.

18
CHECKPOINT 33.2
  • Practice Problem 1
  • List the sequence of events in the transmission
    from a rise in the federal funds rate to a change
    in the inflation rate.

19
CHECKPOINT 33.2
  • Solution
  • When the Fed raises the federal funds rate, other
    short-term interest rates rise and the exchange
    rate rises.
  • The quantity of money and supply of loanable
    funds decrease and the long-term real interest
    rate rises.
  • Consumption expenditure, investment, and net
    exports decrease.
  • Aggregate demand decreases.
  • Eventually the real GDP growth rate and the
    inflation rate decrease.

20
CHECKPOINT 33.2
  • Practice Problem 2
  • The economy has slipped into recession and the
    Fed takes actions to lessen its severity.
  • What action does the Fed take?
  • Illustrate the effects of the Feds actions in
    the money market and the loanable funds market.

21
CHECKPOINT 33.2
  • Solution
  • The Fed lowers the federal funds rate.
  • When the Fed lowers the Federal funds rate, other
    short-term interest rates fall and the supply of
    money increases.

22
CHECKPOINT 33.2
  • The lower federal funds rate increases the supply
    of bank loans, which increases the supply of
    loanable funds.
  • The real interest rate falls.

23
CHECKPOINT 33.2
  • Practice Problem 3
  • The Fed thinks that the economy is about to slip
    into recession and takes actions to lessen its
    severity.
  • Explain how the Feds actions change aggregate
    demand and real GDP.

24
CHECKPOINT 33.2
  • Solution
  • A lower real interest rate (and lower exchange
    rate) and a greater quantity of money and loans
    increase aggregate expenditure.
  • Aggregate demand increases and the AD curve
    shifts to AD0 ?E.
  • A multiplier effect increases aggregate demand
    and the AD curve shifts rightward to AD1.
  • Real GDP increases and recession is avoided.

25
CHECKPOINT 33.2
  • In the news
  • The Feds tricky balancing act
  • The FOMC was a bit more optimistic about the
    economy recovering, but said that policy
    tightening was not going to happen any time soon.
  • Source Business Week, June 6, 2009
  • What are the ripple effects and time lags that
    the Fed must consider in deciding when to start
    raising the federal funds rate?

26
CHECKPOINT 33.2
  • Solution
  • The figure describes the ripple effects and the
    time lags.
  • The Fed can influence interest rates quickly, but
    several months pass before the quantity of money
    and loans respond, up to a year before
    expenditure plans respond, and up to two years
    before the inflation rate responds to the Feds
    interest rate actions.

27
CHECKPOINT 33.3
  • Practice Problem 1
  • What are the three alternative monetary policy
    strategies that the Fed could have adopted?
  • Why is discretionary monetary policy not one of
    them?

28
CHECKPOINT 33.3
  • Solution
  • The Fed could have adopted three alternative
    monetary policy strategies
  • 1 Inflation targeting rule
  • 2 A k-percent monetary targeting rule
  • 3 A nominal GDP targeting rule
  • A rule-based monetary policy beats discretionary
    monetary policy because it provides a more secure
    anchor for inflation expectations, which in turn
    makes long-term contracting in labor and capital
    markets more efficient.

29
CHECKPOINT 33.3
  • Practice Problem 2
  • Why does the Fed not target the quantity of money?

30
CHECKPOINT 33.3
  • Solution
  • The Fed does not target the quantity of money
    because it believes that the demand for money is
    too unstable.
  • Fluctuations in the demand for money would bring
    unwanted fluctuations in interest rates,
    aggregate demand, and real GDP and the inflation
    rate.

31
Study Plan Problem The Fed does not target the
quantity of money because the Fed believes that
_______.
CHECKPOINT 33.3
  1. it does not have enough control over the quantity
    of money because it is the banks that determine
    the quantity of loans and deposits.
  2. changes in the demand for money would occur,
    which would increase the interest rate and slow
    the growth of aggregate demand.
  3. The quantity of money should be fixed.
  4. Technological change in the banking system leads
    to large and unpredictable shifts in the demand
    for money curve, which makes the use of money
    targeting unreliable.

32
CHECKPOINT 33.3
  • Practice Problem 3
  • Which countries practice inflation targeting?
  • How does inflation targeting work?
  • Does inflation targeting achieve lower inflation
    rates?

33
CHECKPOINT 33.3
  • Solution
  • The countries that practice inflation targeting
    are the United Kingdom, Canada, Australia, New
    Zealand, Sweden and the Eurozone (the European
    countries that use the euro).

34
CHECKPOINT 33.3
  • Inflation targeting works by
  • Announcing a target inflation rate
  • Setting the overnight interest rate (equivalent
    to the federal funds rate) to achieve the target
  • Publishing reports that explain how and why the
    central bank believes that its current policy
    actions will achieve its ultimate policy goals.
  • Only Eurozone and New Zealand have missed their
    inflation targets, but the others targeters have
    achieved their targets.

35
CHECKPOINT 33.3
  • In the news
  • One tool, one goal
  • The one-tool, one-goal rule by which central
    banks operated has gone. Monetary policy is now a
    messier business.
  • Source The Economist, April 25, 2009
  • What is the tool and the goal that the news clip
    says is gone?
  • What is the problem with messy monetary policy?

36
CHECKPOINT 33.3
  • Solution
  • The tool is the overnight interest rate (the
    federal funds rate in the United States). There
    never has been one goal for U.S. monetary policy.
  • The Feds dual mandate is low inflation and
    maximum employment.
  • Even the central banks that have a formal
    inflation target pay attention to the output gap
    and unemployment rate.
  • The problem with messy monetary policy is that
    it might fail to anchor inflation expectations
    and lead to a worsening of the short-run policy
    tradeoff.
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