ch. 31: monetary policy

• Achieving the goal of moderate long-term interest rates means

keeping long-term nominal interest rates close to long-term real interest rates

• Achieving the goal of stable prices means

keeping the inflation rate low

• During the financial crisis and recession of 2008-2009,

the Fed lowered the federal funds rate target to the floor

• The lower the real interest rate

the greater is the amount of consumption expenditure and the smaller is the amount of saving

• The lower the real interest rate

the greater is the amount of investment

• The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall

maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates

• When the Fed lowers the federal funds rate

other short-term interest rates and the exchange rate also fall→ quantity of money and supply of loanable funds increase→ long-term real interest rate falls→ increases consumption expenditure and investment

• To pursue the goals of monetary policy,

, the Fed must make the general concepts of price stability and maximum employment precise and operational

• Achieving the goal of maximum employment means

attaining the maximum sustainable growth rate of potential GDP and keeping real GDP close to potential GDP

• The Fed faces a tradeoff→

between inflation and interest rates and between inflation and real GDP

• The Fed pays attention to two measures of inflation

consumer price index (CPI) and personal consumption expenditure (PCE)

• Price stability is key→

delivers moderate long-term interest rates because the nominal interest rate reflect the inflation rate

• The lower the interest rate,

the lower is the exchange rate and the greater are the exports and the smaller are imports

• Federal funds rate

the market in which the banks borrow and lend overnight is called the federal funds market and the interest rate is federal funds rate

• The Fed has two possible instruments:

the monetary base or the interest rate at which banks borrow and lend monetary base overnight

• The higher the federal fund rate,

the smaller is the quantity of reserves