Chapter 18-19 monetary policy instruments

What is the reserve requirement?

As of 1980 all depository institutions are subject to the same reserve requirement

if federal funds rate is less than discount rate....

Banks will not borrow from the fed and borrowed reserves are zero

Borrowing from the fed is a substitute for what?

Borrowing from other banks

When the federal funds rate is above the rate paid on excess reserves, ier, as the federal funds rate _______, the opportunity cost of holding excess reserves ____ and the quantity of reserves demanded _____

Decreases, falls, rises

What are the disadvantages of inflation targeting?

Delayed signaling too much rigidity potential for increased output fluctuations low economic growth during disinflation

With high demand for reserves, FF rate = ?

Discount rate

What are the advantages of inflation targeting?

Does not rely on one variable to achieve target Easily understood Reduces potential of falling in time-inconsistency trap Stresses transparency and accountability

Advantages of Implicit nominal anchor?

Does not rely on stable money-inflation relationship Demonstrated success in US

What does the demand curve look like in the market for reserves?

Downward sloping curve that becomes flat (infinitely elastic) at the rate paid on excess reserves

What happens when lowering the discount rate?

Shifts supply curve down and lowers federal discount rate (if along the downward sloping intersection of supply and demand)

What effect does a change in the interest rate have?

Shifts up flat part of demand curve for reserves

What is the interest rate paid by the fed on reserves in comparison to the federal funds rate target?

Since 2008 it has been a fixed amount below the federal funds rate

What are the two components of supply in the market for reserves?

non-borrowed and borrowed reserves

What happens when there is excess supply of reserves?

FF rate falls

What happens when there is excess demand for reserves?

FF rate rises

What is the Taylor rule?

Fed funds rate = inflation + equilibrium real fed funds rate + 1/2 (inflation gap) + 1/2 (output gap)

What is the cost of borrowing reserves from the fed?

Federal discount rate

Advantages of monetary targeting?

Immediate signal on achievement of target

What is the response to a change in the required reserves?

Increasing required reserves shifts demand curve to the right, raises FF rate. Decreasing required reserves shifts demand curve left, lowering FF rate

With low demand for reserves, FF rate = ?

Interest rate on reserves

Disadvantages of implicit nominal anchor?

Lack of transparency Success depends on individuals in charge low accountability

What are the three criteria for choosing targets of monetary policy?

Measurability Controllability Ability to predictably affect goals

Changes in the borrowed reserves affect what?

Monetary base

Changes in reserve requirements affect what?

Money multiplier

What are the disadvantages of the reserve requirement?

No longer binding for most banks can cause liquidity problems increases uncertainty for banks

What does NAIRU mean?

Non accelrating interest rate of unemployment. The level of unemployment below which inflation rises

What are the main tools of the central bank?

Open market operations Discount policy Reserve requirements

What are the main goals of monetary policy?

Price stability High employment Economic growth Interest rate stability Financial market stability Foreign exchange market stability

Open market operations affect what?

Quantity of reserves and monetary base

Paying interest on reserves does what?

Reduces effective tax on deposits helps improve implementation of monetary policy Provides liquidity to financial system by avoiding balance-sheet-capacity problem

An open market purchase, when intersection occurs on the downward slope of the demand function, does what?

Reduces the FF rate, whereas an open market sale would cause it to rise

Disadvantages of monetary targeting?

Relies on stable money-inflation relationship

What are the main policy instruments (operating instruments) of the central bank?

Reserve aggregates Interest rates (these two are incompatible with one another)

What are the advantages of Open Market Operations?

The fed has complete control over volume Flexible and precise easily reversed quickly implemented

Federal funds rate is what and does what?

The interest rate on overnight loans from one bank to another, is the primary instrument of monetary policy

What is Phillips Curve Theory?

Theory that below a certain level of unemployment inflation rises.

What determines whether there are effects to an open market operation?

Where on the demand curve equilibrium currently falls