2.27 Monetary Policy

What are the 3-fold goals of the U.S. Fed?

(1) Maximum employment (2) Stable prices (3) Moderate long-term interest rates

Excess reserves lead to what?

Excess reserves lead to a decrease in the FFR as banks are willing to lend reserves to each other.

FFR formula

FFR = 2% + actual inflation + 0.5 x (actual inflation - 2%) + 0.5 x output gap

In adjusting the federal funds rate, the Fed must decide between what 2 rules?

Instrument rules and targeting rules

What does the McCallum rule do?

It focuses on the growth of the monetary base, based on the quantity theory of money (MV=PY)

When the Fed engages in open market purchases of Treasury securities, what happens?

It increases bank reserves.

The increase in aggregate demand puts upward pressure on what?

It puts upward pressure on both the price level (increasing inflation) and employment and real GDP

A rule targeting the exchange rate suggests what?

It suggests that the money supply growth should be adjusted so that the exchange rate between a country's currency and some baskets or index of the currencies of other countries remain stable.

The goal of moderate long-term interest rates is closely tied to what?

It's closely tied to the goal of stable prices, since nominal interest rates are real rates plus expected inflation.

What is the "output gap"?

It's the gap between the actual growth rate and the potential growth rate of real GDP and is an important consideration in setting monetary policy.

What are long-term interest rates?

Long-term interest rates are short-term rates plus a premium for expected inflation

What things tend to increase aggregate demand?

The increase in business investment, consumer purchases of durable goods, and exports

What is the Federal funds rate?

it is the interest rate that banks charge each other for overnight loans of reserves.

What is a targeting rule?

A targeting rule is based on a forecast of future inflation and requires that the FFR be set so that the forecast of inflation is equal to the target inflation rate.

How does the Fed influence the FFR?

By increasing or decreasing reserves, primarily through "open market operations."

Core inflation is calculated as what?

Core inflation is calculated as the rate of increase in the CPI with the most volatile components removed.

What does it mean for the dollar to depreciate relative to other currencies?

More dollars per foreign currency ratio

When the output gap is negative, we have a "recessionary gap" and an expansion of money and credit aggregates is indicated.

OK

What are Open Market Operations

OMO are the buying or selling of Treasury securities by the Fed in the open market.

What is "inflation targeting"?

Practiced by many central banks. The central bank makes its inflation expectations explicit and uses open market operations and manages the overnight rate in such a way as to bring expected inflation in line with the target rate.

The FFR is determined by what?

The FFR is determined by the supply and demand in the market for interbank loans of reserves.

What is the Taylor rule?

The Taylor rule is an instrument rule based on the rate of inflation and on the output gap.

What is the primary way that the Fed conducts monetary policy?

The primary way that the Fed conducts monetary policy is through their influence on the Federal Funds rate.

When following an instrument rule, the monetary authorities base their target federal funds rate on what?

The target federal funds rate is based on the current performance of the economy.

What is the target inflation rate?

The target inflation rate is typically 2%

Are lending reserves and buying T-bills close substitutes?

Yes