Chapter 14

unemployment rate

if the ... rate is below the natural unemployment rate, a labor shortage might put pressure on wage rates to rise, which might feed into inflation. The Fed might consider raising the federal funds rate. If the unemployment rate is above the natural unemployment rate, a lower inflation rate is expected. The Fed might consider lowering the federal funds rate.

output gap

if the output gap is positive, it is an inflationary gap and the inflation rate will most likely accelerate. The Fed might consider raising the federal funds rate. If the output gap is negative, it is a recessionary gap and inflation might ease. The Fed might consider lowering the federal funds rate.

Operational , "Maximum employment" goal

stable prices is the primary goal, but the Fed pays attention to the business cycle. To gauge the overall state of the economy, the Fed uses the output gap- the percentage deviation of real GDP from potential GDP. A positive output gap indicates increasing inflation. A negative output gap indicates unemployment above the natural rate. The Fed tries to minimize the output gap.

discount rate

the Fed stands ready to make overnight loans to banks at an interest rate. A bank will not borrow from another bank unless the interest rate is lower than or equal to the discount rate. So, the discount rate caps the federal funds rate.

federal funds market

the higher the federal funds rate, the greater is the quantity of overnight loans supplied and the smaller is the quantity demanded. The equilibrium federal funds rate balances the quantities supplied and demanded.

market for bank reserves

lending in the federal funds market is an alternative to holding larger reserves while borrowing is an alternative to holding smaller reserves. Banks hold reserves to meet required reserve ratio and excess reserves to make payments. Because reserves can be loaned in the federal funds market at the federal funds rate, reserves are costly to hold. The higher the federal funds rate, the smaller is the quantity of reserves demanded.

core inflation rate

rate of increase in the core PCE deflator. Excluding fuel and food. The Fed believes that the core inflation rate is less volatile than the CPI inflation rate and provides a better measure of the underlying inflation trend.

federal funds rate

the interest rate at which banks make overnight loans to one another. The Fed's policy instrument is the federal funds rate. The Fed sets a target for the federal funds rate and then takes actions to keep it close to its target. To avoid recession, it lowers the federal funds rate. To check rising inflation, it raises the federal funds rate.

Implementing the policy decision

Having decided the appropriate level for the federal funds rate, how does the Fed get the federal funds rate to move to the target level? The answer is by using open market operations to adjust the quantity of bank reserves. To see how an open market operation changes the federal funds rate, we look at two markets: -the federal funds market -the market for bank reserves

inflation rate

Is the ... rate inside the Fed's comfort zone? If the inflation rate is above the comfort zone or expected to move about it, the Fed considers raising the federal funds rate target. If the inflation rate is below the comfort zone or expected to move below it, the Fed considers lowering the federal funds rate target.

means of achieving the goals

The 200 law instructs the Fed to pursue its goals by maintaining long-run growth of the quantity of money in line with the economy's long-run potential to increase production. That is, the Fed is expected to be able to maintain full employment and keep the price level stable.

Responsibility for monetary policy

The Fed: makes monetary policy decisions. Congress: no role in making monetary policy decisions. The Fed makes two reports a year and the chair testifies before congress( feb and june) President: appointing the members and chair of the board of governors

Corridor

The discount rate and the interest rate paid on bank reserves held at the Fed create a corridor that limits the movement of the federal funds rate. The corridor is .5 percentage points. When the interest rate on reserves is 2.0 percent, the discount rate is 1.5 percent. In normal times, the Fed sets the federal funds rate at the center of the corridor.

Fed's Monetary policy goals: a dual mandate

goals are maximum employment, stable prices, and moderate long-term interest rates. In the long run, these goals are in harmony and reinforce each other. But in the short run, they might be in conflict. The key goal is price stability. Price stability is the source of maximum employment and moderate long term interest rates.

interest on reserves

a bank will not lend reserves unless the interest rate is higher than or equal to the interest rate on reserves. So, the interest rate on reserves sets a floor on the federal funds rate.

monetary policy instrument

a variable that the Fed can directly control or at least very closely target. -monetary base -federal funds rate