Ch 10

Liquidity Provisions (3)

1. Discount windows expansion 2. Term auction facility 3. New lending programs

Tools of Monetary Policy: Reserve Requirements Rarely used as a tool (2)

1. Raising causes liquidity problems for banks 2. Makes liquidity management unnecessarily difficult

Inside the Fed: A Day at the Trading Desk -The trading desk typically uses two types of transactions to implement their strategy:

1. Repurchase agreements (repo): the Fed purchases securities, but agrees to sell them back within about 15 days. So, the desired effect is reversed when the Fed sells the securities back—good for taking defense strategies that will reverse. 2. Matched sale-purchase transaction (reverse repo): where the Fed sells securities, but agrees to buy them back in the near future .

Open Market Operations In the next two slides, we will examine the impact of open market operations conducted through primary dealers (government securities dealers who operate out of private banking institutions). -We will show the following:

- Purchase of bonds increases the money supply - Making discount loans increases the money supply --Naturally, the Fed can decrease the money supply by reversing these transactions.

Liquidity Provisions Term Auction Facility

- another loan facility, offering another $400 billion to institutions. -borrow at a rate lower than the discount rate and determined competitively, rather than being set at a competitive rate -more widely used than discount windows

Monetary Policy Tools of the European Central Bank ECB policy signals by... The EBC has tools to implement its intended policy: (3)

- setting a target financing rate, which establishes the overnight cash rate. 1. open market operations, 2. lending to banks, 3. reserve requirements.

Should Price Stability be the Primary Goal? Which is better, hierarchical or dual mandates? -Dual mandate can lead to... -Hierarchical mandate can lead to... -Answer?

-Dual mandate can lead to increased employment and output, but also increases long-run inflation. -Hierarchical mandate can lead to over-emphasis on inflation alone - even in the short-run. -Answer? It depends. Both help the central bank focus on long- run price stability.

Figure 10.2 Response to Open Market Operations Effect depends on whether the supply curve originally intersects at the sloped or flat section of demand curve -Panel A (sloped intersection)

-an open market purchase leads to a greater quantity of reserves supplied which is shown as NBR1 goes to NBR2. This will lower the funds rate (iff) -an open market sale will decrease the quantity of NBR and will shift the supply curve left and the iff will rise -An open market purchase causes the federal funds rate to fall, whereas a sale causes the federal funds rate to rise

Should Central Banks Respond? The "Greenspan" doctrine for why the answer is no: (5)

1. Bubbles are difficult to identify 2. Rate changes may do nothing 3. Rates are a blunt instrument: affect many asset prices in the economy 4.Resulting slow economy, unemployment, etc., may be worse than the bubble. 5. Policy reactions after the bubble bursts may keep damage at a reasonable level.

Tools of Monetary Policy: -Open Market Operations (2)

1. Dynamic: Change reserves and monetary base 2. Defensive: Offset movements in other factors affecting reserves, typically uses repos -most transactions are conducted in Treasury securities because this market is most liquid and has the largest trading volume

Inflation Targeting: Pros and Cons Advantages (4)

1. Easily understood by the public 2. Helps avoid the time-inconsistency problem since public can hold central bank accountable to a clear goal 3. Forces policymakers to communicate goals and discuss progress regularly 4. Performance has been good!

Tools of Monetary Policy: -Advantages of Open Market Operations (4)

1. Fed has complete control 2. Flexible and precise 3. Easily reversed 4. Implemented quickly

Global: the ECB's Strategy The ECB pursues a hybrid monetary policy, including both monetary targeting and inflation targeting. -Two key pillars:

1. Monetary and credit aggregates are monitored for implications on future inflation and growth 2. Many other variables examined to assess the future economic outlook

Figure 10.3 Response to Change in Discount Rate -The effect depends on whether the demand curve initially intersects the supply curve in the vertical section or the flat section -Panel A (vertical)

There is no discount lending and borrowed reserves, BR= 0 -When the discount rate is lowered by the Fed from i1d to i2d, the horizontal section of the supply curve falls, as in Rs2, but the intersection of the supply curve remains at point 1 (no change in equilibrium of iff) -Since the fed usually keeps the discount rate above its target for the iff, most changes in the discount rate have no effect on the federal rate

The Federal Reserve Balance Sheet - Open Market Purchase from Primary Dealer -$100 million bonds bought from primary dealers -Result?

When the dealer sells the $100 million of bonds to the Fed, the Fed adds $100 million to the dealers deposit account at the Fed, so that reserves in the banking system go up by $100 million

An open market sale leads to..

a contraction of reserves in the banking system PG 210

Should Central Banks Respond to Asset- Price Bubbles? - Credit-driven bubble:

created when easy credit terms spill over into asset prices. And as asset prices increase, further lending is encouraged. - Very dangerous when the bubble ends: the downward spiral can be more damaging than the asset bubble.

When a discount loan leads to an expansion of reserves, which can be lent out, thereby.... When a bank repays its discount loan and so reduces the total amount of discount lending, the...

leading to an expansion in liquidity in the banking system amount of reserves decreases along with liquidity in the banking system

Figure 10.1 Equilibrium in the Market for Reserves Market Equilibrium -When the federal funds rate is above the equilibrium rate at i2ff, -When the federal funds rate is below equilibrium at i1ff,

more reserves are supplied than demanded and so the federal funds rate falls to i*ff, as shown by the downward arrow more reserves are demanded than supplied (excess demand) and so the federal funds rate rises, shown by upward arrow

The Fed injects reserves into the banking system in two ways:

1. Open market operations: central banks purchase/ sale of securities in the open market (primary determinant of changes in reserves in banking system) 2. Loans to banks, referred to as discount loans.

Liquidity Provisions Discount windows expansion

- discount rate lowered several times. (From 100 to 50 then 25 points) -use was limited during crises due to the stigma that the borrowing bank may be desperate for funds and thus in trouble

Signal of progress is delayed

-- Affects of policy may not be realized for several quarters.

Forward Guidance - However, unconditional commitments can be tough, especially if circumstances change. -Becomes a credibility problem. -2003.....

-2003 experience confirmed this: Fed's unconditional commitment of low rates needed to change. -With the unemployment rate over 6%, at its March 2014 meeting the FOMC dropped forward guidance based on unemployment and inflation thresholds.

Should Price Stability be the Primary Goal? Which is better, hierarchical or dual mandates?

-Both hierarchical and dual mandates achieve the natural rate of unemployment. However, usually more complicated in practice. -Also, short-run inflation may be needed to maintain economic output. So, long-run inflation control should be the focus.

Potential for increasing output fluctuations

-May lead to a tight policy to check inflation at the expense of output, although policymakers usually pay attention to output

Inflation Targeting -New Zealand -Canada -UK -Sweden, Finland, Australia, and Spain

-NZ: Passed the Reserve Bank of New Zealand Act (1990) -CA: Established formal inflation targets, starting in 1991 -UK: Established formal inflation targets, starting in 1992, published in Inflation -Sweden, Finland, Australia, and Spain: Followed suit in 1993 and 1994.

Price Stability Goal & the Nominal Anchor Policymakers have come to recognize the social and economic costs of inflation. (3)

1. Price stability (low and stable inflation, most important goal of monetary policy), therefore, has become a primary focus. 2. High inflation seems to create uncertainty, hampering economic growth. 3. Indeed, hyperinflation has proven damaging to countries experiencing it.

Tools of Monetary Policy: Discount Policy -The Fed's discount loans, through the discount window (where banks can borrow reserves from the federal Reserve), are: (3)

1. Primary Credit: 2. Secondary Credit: 3. Seasonal Credit:

Inflation Targeting: Pros and Cons Disadvantages (4)

1. Signal of progress is delayed 2. Policy tends to promote too much rigidity 3. Potential for increasing output fluctuations 4. Usually accompanied by low economic growth

Monetary policy Macroprudential policies can be more difficult to enact: (3)

1. Subject to political pressure 2. Can impact bottom line of firms 3. Institutions are good at finding ways around regulation ---Best policy is not clear.

Should Central Banks Respond? The global financial crisis suggests the answer is yes: (2)

1. Suggests leaning against credit-driven bubbles. 2. Seems easy to identify, but what policies are most effective?

Tools of Monetary Policy: Discount Policy Lender of Last Resort Function

1. To prevent banking panics and failures from spinning out of control and provide resources to banks when no one else would --- Example: Continental Illinois 2. Can also help avoid panics ---Ex: Market crash in 1987 and terrorist attacks in 2001 - bad events, but no real panic in our financial system

Foreign Exchange market stability

A rise in the value of the dollar makes American industries less competitive with those abroad, and declines in the value of the dollar stimulate inflation in the US. -preventing large changes helps companies plan ahead

Forward Guidance

By committing to maintain short-term rates near zero, future short-term rates should also be zero, meaning long-term rates fall.

Seasonal Credit

Designed for small, regional banks (vacation and agricultural areas) that have seasonal patterns of deposits. -interest rate is tied to the average of the federal funds rate and certificate of deposit rates -Fed is contemplating eliminating it due to improvements in credit markets

Inside the Fed: Ben Bernanke and Inflation Targeting The 2007 announcement of the new communication strategy of three year inflation projects will certainly impact the FOMC's objectives. -In 2012,....

FOMC set inflation target at 2% on the PCE deflator. -Indicated this was flexible: focus on both inflation and employment.

Inside the Fed The Global Financial Crisis tested the...

Fed's ability to act as a lender of last resort. -The Fed's efforts during this period to provide liquidity to the banking system. -PRINT or BOOKMARK THIS CHART FOR TEST

Stability of Financial Markets

Federal Reserve System was created in response to the bank panic in 1907 to promote financial stability and avoid financial crises

Secondary Credit

Given to troubled banks experiencing liquidity problems. -interest rate is set at .05% above the discount rate -the interest rate on these loans are set at a higher, penalty rate rate to reflect the less-sound condition of these borrowers

Primary Credit

Healthy banks borrow as they wish from the primary credit facility or standing lending facility. -interest rate= discount rate set higher than the federal funds target by 1% point because fed wants banks to borrow from each other

Macroprudential regulation may be the answer

Increase disclosure requirements and capital requirements, prompt corrective action, monitoring risk-management procedures, and close supervision. --For example, countercyclical capital requirements would dampen credit-booms. As asset prices increase, increase required capital.

Figure 10.5 Response to Change in Discount Rate -The effect in the interest rate the Fed pays on reserves depends on whether the supply curve intersects the demand curve in the downward sloping vs flat section -Panel B (flat section)

Intersecting at the flat section where the equilibrium iff is at the interest rate paid on reserves, a rise in the interest rate on reserves to i2or moves the equilibrium up to point 2 (i2ff=i2or) -When the federal funds rate is at the interest rate paid on reserves, a rise (fall) in the interest rate on reserves raises (lowers) the federal funds rate

Figure 10.1 Equilibrium in the Market for Reserves Supply Curve

NBR= nonborrowed reserves: supplied by the Fed's open market operations BR= Borrowed reserves: amount of reserves borrowed from Fed id= the primary cost of borrowing from the fed is the interest rate charged on the loans (discount rate)

Interest rate stability

Stability is desirable because fluctuations in interest rates can create uncertainty in the economy and make it harder to plan for the future -Central bank may want to reduce upward movements of interest rates as an increase produces large capital losses on long term bonds and mortgages (bad for financial institutions).

Figure 10.5 Response to Change in Discount Rate -The effect in the interest rate the Fed pays on reserves depends on whether the supply curve intersects the demand curve in the downward sloping vs flat section -Panel A (downward sloping section)

The equilibrium of iff is above the interest rate paid on reserves -When the interest rate is raised from i1or to i2or, the horizontal section of the demand curve rises, as in Rd2, but the intersection of the supply/ demand curve stays the same (point 1)

Tools of Monetary Policy: Interest on Reserves

The fed typically sets the interest rate on reserves to be below the federal funds target. In this case interest on reserves will not be used as a tool of monetary policy but instead help provide a floor under the federal funds rate.

An open market purchase leads to....

an expansion of reserves in the banking system -purchase of bonds expands reserves -reserves are assets for the bank, but liabilities for the Fed because the banks can demand payment at any time and Fed is obligated to pay

Negative Interest Rates on Banks' Deposits Central banks in Europe and Japan have started experimenting with...

charging banks negative interest rates on deposits held at the central bank. -Sweden: 2009, Denmark: 2012, etc. -Supposed to encourage banks to lend, as opposed to holding deposits.

Price Stability Goal & the Nominal Anchor - The time-inconsistency problem is the idea that... (definition and 3 bullet points)

day-by-day policy decisions lead to poor long-run outcomes. - Policymakers are tempted in the short-run to pursue expansionary policies to boost output. However, just the opposite usually happens. - Central banks will have better inflation control by avoiding surprise expansionary policies. - A nominal anchor helps avoid short-run decisions.

Figure 10.6 How Operating Procedures Limit Fluctuations in Fed Funds Rate -Our analysis shows that the Federal Reserve's operating procedures....

limit the fluctuations of the federal funds to between ior and id. -If the range between ior and id is kept narrow enough, then the fluctuations around the target will be small.

"Monetary policy" refers to the...

management of the money supply. -The theories guiding the Federal Reserve are complex and often controversial.

ECB Lending to Banks -Like the Fed, the ECB lends to its member banks via its.....

marginal lending facility. -Banks can borrow at the marginal lending rate (sets a ceiling for the overnight market interest rate), which is 100 basis points above the target lending rate.

Tools of Monetary Policy: Reserve Requirements Reserve Requirements are...

requirements put on financial institutions to hold liquid (vault) cash again checkable deposits. -Everyone subject to the same rule for checkable deposits: -- 3% of first $48.3M, 10% above $48.3M -- Fed can change the 10% Percentages are different in book PG 222

The Market for Reserves and the Federal Funds Rate We will now examine how this change in reserves affects the federal funds rate,...

the rate banks charge each other for overnight loans.

Should Price Stability be the Primary Goal? Price stability is not inconsistent with the other goals in the long- run. -However,...

there are short-run trade-offs. -An increase in interest rates will help prevent inflation, but increases unemployment in the short-run.

Quantitative Easing vs. Credit Easing How does credit easing work?

- Liquidity can help unfreeze markets that have seized and can now allocate capital to productive uses. - Asset purchases can increase demand and lower rates on those assets, focusing on specific markets.

Tools of Monetary Policy: Discount Policy -Really needed? What about the FDIC? 2 Problems:

- Problem 1: FDIC only has about 1% of deposits in the insurance trust - Problem 2: over $1.1 trillion are large deposits not insured by the FDIC because they exceed the $250,000 limit

Policy tends to promote too much rigidity

--Limits policymakers ability to react to unforeseen events -- Usually "flexible targeting" is implemented, focusing on several key variables and targets modified as needed

Should Price Stability be the Primary Goal? -The ECB uses a.. -The Fed uses a....

-hierarchical mandate, placing the goal of price stability above all other goals. -dual mandate, where "maximizing employment, stable prices, and moderate long-term interest rates" are all given equal importance.

Inflation targeting involves: (5)

1. Announcing a medium-term inflation target 2. Commitment to monetary policy to achieve the target 3. Inclusion of many variables to make monetary policy decisions 4. Increasing transparency through public communication of objectives 5. Increasing accountability for missed targets

Monetary policy -Low interest rates may be the "risk-taking channel of monetary policy" (3)

1. Asset managers search for high yield 2. Asset demand may increase 3. Lenders consider riskier projects -Perhaps just use macroprudential policies?

Large-Scale Asset Purchases: to lower interest rates for particular types of credit (AKA Quantitative Easing) (3)

1. Nov 2008: QE1 established, purchasing $1.25 trillion in MBSs. -to lower interest rates on residential mortgages and stimulate housing market 2. Nov 2010: QE2, Fed purchases $600 billion in Treasuries, lower long-term rates. -stimulate investment spending/ economy 3. Sept 2012: QE3, Fed commits to buying $40 billion in MBSs each month. (combo of QE1+2) -not a fixed dollar amount, but instead open ended

Forward Guidance - Commitment to low fed funds rate is...

conditional, predicted on a weak economy. - Could make an unconditional commitment to keep rates low, regardless of the economy. Stronger because it does not suggest the commitment will be abandoned and will have a greater effect on long term interest rates

How Fed Actions Affect Reserves in the Banking System -All banks have an account at the Fed in which they hold deposits. -Reserves consist of.. -2 categories:

deposits at the Fed plus currency that is physically held by banks. Two categories: 1. Required reserves: reserves the Fed requires banks to hold 2. Excess reserves: any additional reserves banks choose to hold

Should Central Banks Respond to Asset- Price Bubbles? -Optimism- Driven Bubble

driven by overly optimistic expectations of asset pricing. -Ex., the tech bubble of the late- 1990s. - These bubbles are less dangerous, as the impact on the financial system is limited. Resulting wealth transfers are not good for the economy.

Case: How Operating Procedures Limit Fluctuations in Fed Funds Rate -Changes in the demand for reserves will not affect the...

fed funds rate: borrowed reserves will increase to match the demand! -This is true whether the demand increases, or decreased.

Quantitative Easing vs. Credit Easing Fed Chairman Ben Bernanke argues that the Fed....

has been engaged in credit easing (altering composition of Fed's balance sheet to improve functioning of particular segments of credit markets), actions to impact credit markets.

Quantitative Easing v. Credit Easing - QE programs dramatically...

increases the Fed's balance sheet. ($900 billion to $4 trillion) - Power force to stimulate the economy, but perhaps also lead to inflation?

Forward Guidance - Fed started this policy in...

late 2008, committing to hold rates low through mid-2015. - Long rates fell, although cause not clear.

Figure 10.6 How Operating Procedures Limit Fluctuations in Fed Funds Rate -If demand for reserves has a large unexpected decrease the demand will shift

left and the supply curve intersects the demand curve on the flat section where iff= interest paid on reserves (ior) -No matter how far the demand curve shifts left, the equilibrium iff will stay at ior because excess reserves will just keep on increasing so that the quantity demanded of reserves equals the quantity of NBR supplied

ECB Open Market Operations Like the Fed, open market operations are the primary tool to implement the policy. -The ECB primarily uses......

main refinancing operations (like repos) via a bid system from its credit institutions. --Involve weekly reverse transactions that are reversed in 2 weeks -Operations are decentralized: carried out by each nation's central bank. -Also engage in long-term refinancing operations, but not really to implement policy. --smaller source of liquidity; carried out monthly with maturity of 3 months

Figure 10.6 How Operating Procedures Limit Fluctuations in Fed Funds Rate -If demand for reserves has a large unexpected increase the demand will shift

right, where it not intersects the supply curve on the flat section. (iff=id) -no matter how far the demand curve shifts to the right, the equilbrium iff will stay at id because borrowed reserves will continue to increase, matching the increase in demand.

ECB Interest on Reserves -Like the Fed, ECB has a deposit facility, where banks can....

store excess cash and earn interest. - As previously discussed, the interest rate is not always positive (negative starting in July 2014). -The deposit facility: provides a floor for the overnight market interest rate.

Price Stability Goal & the Nominal Anchor - Policymakers must establish a nominal anchor which...

ties down the price level to achieve price stability. -For example, "maintaining an inflation rate between 2% and 4%" might be an anchor. - An anchor also helps avoid the time-inconsistency problem.

Figure 10.1 Equilibrium in the Market for Reserves Supply Curve -If the Iff is below the discount rate id, then banks..

will not borrow from the Fed and borrowed reserves will be zero because borrowing in the federal markets is cheaper -Thus, as long as iff remains below id, the supply of reserves will equal the amount of NBR supplied by the Fed and so the supply curve will be vertical

Quantitative Easing vs. Credit Easing -However, short-term rate is already near....

zero: not clear further action helps. - Banks are not lending - Money supply did not expand

Usually accompanied by low economic growth

- Probably true when getting inflation under control - However, economy rebounds

Liquidity Provisions New Lending Programs

-included lending to IBs, and lending to promote purchase of asset-backed securities.

Nonconventional Monetary Policy Tools and Quantitative Easing The Global Financial Crisis challenged the Fed's ability to stabilize the economy: (2)

1. Financial system seized: unable to allocate capital to productive uses 2. Zero-lower-bound problem: central bank is unable to lower the policy interest rate further because it has hit a floor zero. -could take rates below zero -The problems called for the use of nonconventional tools.

Other Goals of Monetary Policy (5)

1. High employment 2. Economic growth (natural rate of output) 3. Stability of financial markets 4. Interest-rate stability 5. Foreign exchange market stability --These goals are often in conflict

Nonconventional Monetary Policy Tools take four forms

1. Liquidity Provision 2. Asset Purchases 3. Forward Guidance 4. Negative interest rates

Should Central Banks Respond to Asset- Price Bubbles? - What should central banks do about pricing bubbles? (3)

1. Should response be different from inflation and employment goals? 2. Should response minimize damage when bubble bursts? 3. Clean-up after bubble bursts?

Conventional Monetary Policy Tools (4)

1. open market operations, 2. discount lending, 3. reserve requirements 4. Paying interest on reserves

ECB Reserve Requirements - Like the Fed, ECB requires banks to hold....

2% of checkable deposits, plus a minimum reserve requirement. - The ECB does pay interest on reserves, unlike the Fed.

Figure 10.4 Response to Change in Required Reserves

When the required reserves ratio increases, required reserves and the quantity of reserves demanded increase for any given interest rate -A rise in the required reserves ratio shifts the demand curve right to Rd2 and moves the equilibrium point to 2 and raises the federal funds rate to i2ff. -When the fed raises (decreases) reserve requirements, the federal funds rate rises (falls)

Figure 10.1 Equilibrium in the Market for Reserves Demand Curve -If the federal funds rate falls below the rate paid on reserves,

banks would not lend in the overnight market at a lower rate and instead they would keep on adding to their holdings of excess reserves indefinitely. The result is that the Rd becomes flat (infinitely elastic)

Inside the Fed: A Day at the Trading Desk -The staff reviews the activities of the prior day and issue forecasts of factors affecting the supply and demand for reserves. -This information is used to determine...

reserve changes needed to obtain a desired fed funds rate. -Government securities dealers are contacted to better determine the condition of the market. -Projections are compared with the Monetary Affairs Division of the BOG, and a course of action is determined. -Once the plan is approved, the desk carries out the required trades, via the TRAPS system.

Figure 10.1 Equilibrium in the Market for Reserves Supply Curve -However, if the federal funds rate were to rise even infinitesimally above the discount rate,

banks would want to keep borrowing more and more at id and then lending out the proceeds in the federal market at the higher rate, iff. The result is that the federal funds rate can never rise above the discount rate and the supply curve becomes flat (infinitely elastic) at id

Negative Interest Rates on Banks' Deposits Banks could just hold cash instead of depositing money with the central bank. But.....

the costs of that (vaults, guards, security systems) is high. -Lower profitability might lead to banks to lend less. -Results not clear. -The U.S. Fed announced that it would not use negative interest rates as a tool.

Figure 10.1 Equilibrium in the Market for Reserves Demand Curve -When the federal funds rate is above the rate paid on excess reserves (ior), as the federal rate decreases,

the opportunity cost of holding excess reserves falls, then the quantity of reserves demanded rises.

How Fed Actions Affect Reserves in the Banking System -The Fed sets the required reserve ratio:

the portion of deposits banks must hold in cash. Any reserves deposited with the Fed beyond this amount are excess reserves.

Tools of Monetary Policy: Discount Policy -But there are costs!

Banks and other financial institutions may take on more risk (moral hazard) knowing the Fed will come to the rescue

Inside the Fed: Ben Bernanke and Inflation Targeting Well-authored on the implementation and impact of inflation targeting while a professor at Princeton. Speech in 2004 suggests the...

Fed will continue to move toward inflation targeting. -However, comments since taking over the Fed suggest he will look for consensus here before acting.

Figure 10.2 Response to Open Market Operations Effect depends on whether the supply curve originally intersects at the sloped or flat section of demand curve -Panel B (flat intersection)

If the supply curve initially intersected on the flat section, open market operations have no effect on the federal funds rate -Equilibrium moves from point 1 to 2, but the iff remains unchanged at ior because The interest rate paid on reserves, ior, sets a floor for the federal funds rate

Should Central Banks' Respond to Asset-Price Bubbles? Lessons from the Global Financial Crisis Asset pricing bubbles occur when (2)

1. asset's prices climb above fundamental values 2. ... then fall back to the fundamental value (or below) quite rapidly

Economic growth

Directly encourage firms to invest or by encouraging people to save, which provides more funds for firms to invest -closely related to high unemployment goal: if unemployment is low (high) then firms are more (less) likely to invest -Supply side economics policies: tax incentives to spur economic growth

Figure 10.3 Response to Change in Discount Rate -The effect depends on whether the demand curve initially intersects the supply curve in the vertical section or the flat section -Panel B

On the flat section there is some discount lending and changes in the discount rate do affect the federal funds rate (iff). -Initially discount lending in positive and the equilibrium iff= id (discount) -When the discount rate is lowered to id2, the horizontal section of the supply curve falls Rs2, moving equilibrium to point 2 and the iff falls to i2ff.

high unemployment

Want demand = supply, or natural rate of unemployment -Natural Rate of Output: output produced at natural rate of unemployment -Full employment is not = to 0 people unemployed -Frictional Unemployment: searches by workers and firms to find suitable matchups, is beneficial to the economy -Structural unemployment: mismatch between job requirements and skills of locally available workers