Econ 102 Ch. 29 - Monetary Policy
What is the formula for real income?
%change in real income = %change in nominal income - %change in price level
What are defensive actions? What is an example?
- actions to maintain current monetary policy - Fed buys bonds during emergencies
When does the AD curve in the graph shift right? left?
- right when there is expansionary monetary policy - left when there is contractionary monetary policy
What are open market operations? How does the Fed use this to influence money supply?
- the Fed buys and sells Treasury bills and bonds - open market purchase: expand money supply = buy bonds - open market sale: contract money supply = sell bonds
What is a monetary policy?
a policy made in response to various situations (too chaotic)
What is a monetary regime?
a predetermined statement of the policy that will be followed in various situations (favored)
What is the structure of the Fed?
- Federal Open Market Committee (FOMC): Fed's chief body, decides monetary policy (Board of Governors + 5 Fed bank presidents) - Board of Governors: oversee regional reserve banks (7 members appointed by the Pres. and confirmed by Senate, 14-year term) - Regional Reserve Banks: (12 regional banks, 25 branches) * review w/ image *
What is a central bank? What is the central bank of the US?
- an institution that oversees the banking system and regulates the money supply - the Fed (neither private nor public)
What is monetary policy? Who controls it?
- policy with changes in the banking system's reserves that influence money supply, availability of credit, and interest rates - the Fed controls it
What are the limits of the Fed's control of the interest rate?
- the Fed can only change the slope of the yield curve, it cannot shift it up or down - the Fed's ability to control long-term interest rates is lessening bc of increasing liquidity and technology
What is a reserve requirement? What happens when the Fed changes the reserve requirement?
- the percentage of reserves that the a bank has to keep - raise requirement: lower money supply - lower requirement: raise money supply
What is the monetary base?
- vault cash + Fed deposits + currency in circulation - this is how the Fed influences the amount of money in the economy
What is a yield curve? inverted yield curve?
- yield curve: shows the relationship between interest rates and bonds' time to maturity - inverted: when the short-term rate is higher than the long-term rate - usually happens during contractionary monetary policies
What are the five components of the monetary policy graph?
1. AD curve 2. SRAS curve 3. LRAS curve 4. x-axis: real output 5. y-axis: price level
What are the six duties of the Fed?
1. conducting monetary policy 2. supervising/regulating financial institutions 3. serving as a lender of last resort to financial institutions 4. providing banking services to the US government 5. issuing coin and currency 6. providing financial services to commercial banks, savings and loan associations, and credit unions
What are the Fed's four intermediate targets?
1. consumer confidence 2. stock prices 3. interest rate spreads 4. housing starts
What are the Fed's four ultimate targets?
1. stable prices 2. sustainable growth 3. acceptable employment 4. moderate interest rates
What is the Taylor rule formula? What is the purpose of the formula? How accurate is it?
2 + current inflation + 0.5(actual inflation - target inflation) + 0.5(deviation from potential output) - the formula determines the target fed funds rate - "reasonably accurate"
What are offensive actions?
actions to have expansionary/contractionary effects on the economy
What are the advantages/disadvantages of contractionary policy?
advantages: - less trade deficit - fights inflation disadvantages: - more unemployment - higher interest rates - risks recession - slows growth
How does expansionary monetary policy affect real interest rates?
expansionary monetary policy increases expected inflation which can increase nominal rates and leave real interest rates unchanged
What monetary tool did the Fed add in 2008?
interest payments on bank reserves
What is contractionary monetary policy?
money supply decreases -> interest rates increase -> investments and output decrease - decreases aggregate demand
What is expansionary monetary policy?
money supply increases -> interest rates decrease -> investments and output increase - increases aggregate demand
What are Fed funds?
overnight loans that banks give to one another. a bank in surplus lends money to a bank in shortage
What is the formula for real interest rates?
real ir = nominal ir - expected inflation (inflation can also be referred to as "price level")
Why does the Fed look at the Fed funds rate?
the Fed funds rate determines if monetary policy is tight (increasing rate) or loose (decreasing rate). they stay within a Fed funds rate range by buying or selling bonds
What is the Federal funds rate?
the interest rate banks charge each other for Fed funds
What is the discount rate?
the interest rate for loans from the Fed to a bank
What would happen if there was no reserve requirement?
the money multiplier and supply of money would increase because it could all just be lended
What are reserves?
vault cash or deposits at the Fed
What is a liquidity trap?
when additional reserves go into excess reserves instead of the money supply