Macro Chapter 16: Interest Rates and Monetary Policy
open-market operations
The most frequently used monetary device for achieving price stability is: Answer open-market operations. the discount rate. the reserve ratio. the prime interest rate.
federal funds rate
The prime interest rate is higher than the
Monetary Policy limitations
time lags (recognition, administrative, operational) and potential ineffectiveness during severe recession
Open-market operations
Buying government bonds from or selling government bonds to commercial banks and the general public
Investment demand curve
Downward sloping, inverse relationship between the interest rate and the amount of investment spending
Lowering the reserve ratio
Enhances the ability of banks to create new money by lending. It increases the amount of excess reserves and the size of the monetary multiplier
An asset demand for money
Extent to which people want to hold money as an asset (downward sloping demand line on graph)
The Taylor Rule
FFR* = Change in PC +FFRaverage of last 5 years + 1/2 (change in Pc - Change in PC*) + 1/2 (GDP - GDP fe / GDPfe) FFR* = Change in current inflation rate + long term average of FFR + 1/2 inflation gap + 1/2 GDP Gap
Operation Twist
Forward commitment began 2011, Maturity Extension Program Operation Twist The Fed preannounced that by the end of 2012, it would purchase $677 billion in long-term govt bonds while simultaneously selling an equivalent dollar amount of short-term govt bonds Stayed near 0 while longer-term rates fell
Securities
Government bonds that have been purchased by the Federal Reserve Banks
Zero Lower Bound Problem
Growth weakened so this was introduced, a central bank is constrained in its ability to stimulate the economy through lower interest rates by the fact that nominal interest rates cannot be driven lower than zero
Restrictive monetary policy
Increases the Federal funds rates, reduces the money supply, and increases other interest rates
The price paid for the use of money
Interest
making it less expensive for commercial banks to borrow from the central banks
Lowering the discount rate has the effect of: Answer changing required into excess reserves. changing excess into required reserves. making it less expensive for commercial banks to borrow from the central banks. forcing commercial banks to call in outstanding loans from their best customers
Expansionary monetary policy
Lowers the Federal funds rates, increases the money supply, and lowers other interest rates
Buy bonds/securities
Open Market Operations: Expansionary Policy
Sell bonds/securities
Open Market Operations: Restrictive Policy
The Fed's 6 tools of monetary control to alter the reserves of commercial banks
Open-market operations; the reserve ratio; the discount rate; the term auction facility, quantitative easing, interest on reserves
Raising the reserve ratio
Reduces the supply of money
Decrease reserve ratio
Reserve Ratio: Expansionary Policy
Decrease discount rate
The Discount Rate: Expansionary Policy
Increase discount rate
The Discount Rate: Restrictive Policy
Zero Interest Rate Policy (ZIRP)
The Fed aimed to keep short-term interest rates near zero to stimulate the economy Open market operations were used to keep the FFR between 0 and .25%
Term auction facility
The Fed holds two auctions each month at which banks bid for the right to borrow reserves for 28-day and 84-day periods.
banks; other banks
The Federal funds rate is the interest rate that _______ charge(s) ______. Answer banks; other banks the Fed; commercial banks banks; their best corporate customers banks; on federal student loans
a full-employment, noninflationary level of total output
The fundamental objective of monetary policy is to assist the economy in achieving: Answer a rapid pace of economic growth. a money supply that is based on the gold standard. a full-employment, noninflationary level of total output. a balanced budget consistent with full employment
Commercial banks
The interest rate is the rate the Fed charges interest on loans granted to
Buying government securities and lowering the discount rate
The major problem facing the economy is high unemployment and weak economic growth. The inflation rate is low and stable. Therefore, the Federal Reserve decides to pursue a policy to increase the rate of economic growth. Which policy changes by the Fed would reinforce each other to achieve that objective? Answer Selling government securities and raising the discount rate Selling government securities and lowering the discount rate Buying government securities and lowering the discount rate Buying government securities and raising the reserve ratio
The Federal Funds Rate
The rate of interest that banks charge one another on overnight loans made from temporary excess reserves.
Total Demand for money
The total amount of money the public wants to hold, both for transactions and as an asset, at each possible interest rate, is called (downward sloping demand line on graph)
Inverse
What is the relationship between interest rates and bond prices?
The reserves of the commercial banks increase
When the Fed decides to purchase government bonds
Decrease
When the Fed sells government bonds, what happens to the commercial bank reserves?
The Equilibrium Interest Rate
Where money supply and money demand meet, money demand is downward sloping and money supply is vertical
Cyclical asymmetry
Which one is considered a problem with monetary policy? Answer Dollar depreciation Cyclical asymmetry Isolation from political pressure A change in the discount rate
Transactions, speculation, emergencies
Why do we want to hold onto money?
Responses to slow moving economy after 2007-2009 recession
Zero Interest Rate Policy (ZIRP) Zero Lower Bound Problem Quantitative Easing Forward Commitment (Operation Twist)
Monetary policy advantages over fiscal policy
speed and flexibility, and isolation from political pressure
The prime interest rate
the benchmark interest rate used by banks as a reference point for a wide range of interest rates charged on loans to businesses and individuals.
Increase reserve ratio
Reserve Ratio: Restrictive Policy
The two main assets of the Fed
Securities and Loans
Forward Commitment
-Pronouncing exactly how much it was going to buy during QE2 and how low the buying would last -Makes banks more likely to lend new reserves because they wouldn't have any nagging doubt that the Fed might suddenly reverse policy, reduce reserves, and force the bank to suddenly and unexpectedly reduce their lending activities
Quantitative Easing
-Response to zero bound problem, it looks like open market operations but differs because it is not intended to lower interest rates, just increasing the quantity of reserves in the banking system -QE can involve the purchase of US govt bonds and also debt issued by government agencies or government backed corporations -Began in March 2009
Three main liabilities of the Fed
1. reserves of commercial banks 2. treasury deposits 3. federal reserve notes outstanding
Decrease the interest rate
Interest on Reserves: Expansionary Policy
Increase the interest rate
Interest on Reserves: Restrictive Policy
QE3
September 2012, Fed announced that it would purchase $85 billion per month in bonds and that they had no specific end date and would continue until the employment situation improved
The transactions demand for money
The demand for money as a medium of exchange (vertical demand line on graph)
