Monetary Policy
Taylor Rule
A rule developed by John Taylor that links the Fed's target for the federal funds rate to economic variables.
Trouble Assets Relief Program (TARP) "The Bailout"
The Bailout is NOT The Stimulus; The Stimulus is NOT The Bailout TARP signed by President Bush in 2008 Allow the Treasury and the Fed to purchase "Toxic Assets" from large banks intent: get them to start making loans again; unstop the credit markets... up to $700 Billion
Shifts in the Money Demand Curve:
The two most important variables that cause the money demand curve to shift are Real GDP and The Price Level.
The Demand for Money
When interest rates rise on financial assets such as U.S. treasury bills, the amount of interest that households and firms lose by holding money increases. When interest rates fall, the amount of interest households and firms lose by holding money decreases. Opportunity cost is what you have to forgo to engage in an activity. The interest rate is the opportunity cost of holding money.
Equilibrium in the Money Market
When the Fed increases the money supply, the short-term interest rate must fall until it reaches a level at which households and firms are willing to hold the additional money.
First model of the interest rate: Loanable funds model
concerned with long-term real rate of interest, which is the interest rate that is most relevant when savers consider purchasing a long-term financial security such as a corporate bond. It is also the rate of interest that is most relevant to firms that are borrowing to finance long-term investment projects such as new factories or office buildings, or to households that are taking out mortgage loans to buy new homes.
Lower Interest Rates affect AG Consumption by
lower interest payments on loans will increase household spending on consumer durable goods. Will also reduce the incentive for households to want to save and instead spend their money more.
The Fed and Monetary Policy
Fed can use the monetary policy to affect the price level and, in the short run, the level of real GDP, allowing it to attain it's policy goals of high employment and price stability.
Procyclical Policy
Increases the severity of the business cycle.
NINA Loan
No Income No Assets
Liquidity Trap
Short-term interest rates are pushed to zero, leaving the central bank unable to lower them further
Quantitaive Easing (QE)
involves buying securities beyond the short-term government securities that are usually involved in open market operations
Interest Rates
-Interest rates tend to move together -Not perfectly together, but in general -Both the interest rate you RECEIVE (on a treasury bond) -And the interest rate you PAY (on a mortgage)
Federal Reserves Quantitative Easing
-goal; lower long term interest rates -fed had a problem -normally it lowers short-term interest rates, they where already almost zero! pg 524 1.) Fed sells a bunch of short term bonds 2.) Selling bonds lowers their prices, raising rates 3.) Uses that money to BUY longer terms bonds 4.) Buying bonds increases their prices, lowering long-term rates 5.) Longer-term interest rates goes down. they affect houses
Federal Reserves Quantitative easing 2
-houses -lots of home mortgages associated ( move in sync with) 10 year treasury rate.
ARM (Adjustable Rate Mortgage)
-pay 2% interest for first two years -pay 4% interest for next two years -Collateralized Debt Obligations (CD))
Federal Fund Rate
0-0.25%
Increase in Real GDP
Amounts of buying and selling goods and services will increase. This additional buying and selling increases the demand for money as a (medium of exchange), so the quantity of money households and firms increases at each interest rate, shifting the demand curve to the right.
quantitative easing
Bonds: price of bond goes down, rate it pays goes up. 1.) Price of bonds goes up, rate they pay (rate you receive) goes down 2.) interest rates- whether paying or receiving, go up or down together 3.) if rate people are receiving (on bonds) goes down, rate people pay on things (car, houses) should go down too. 4.) So somehow, increasing the prie of bonds should LOWER interest rates people pay on things like car loans, house loans.
A decrease in the interest rate
Causes an increase in the quantity of money demanded.
Market For Loanablle Funds
Concerned with Long-Term Interest Rates 1.) Investor buying a corporate bond 2.) Business undertaking investment 3.) Consumer buying a house
Money Market
Concerned with Shorter-Term interest rates 1.) Fed Funds Rate
Taylor Rule Formula
Current inflation rate + Real federal funds rate + (.5)(Inflation gap)+(.5)(output gap)
Choosing a Monetary Policy Target
Fed can use either the money supply or interest rate as its monetary policy target. Fed has generally focus on the interest rate. The Fed has targeted the interest rate "Federal Fund Rate"
Changes in the interest rate does what to the Money supplied?
Has no effect on the quantity of money supplied.
Higher interest rates affect AG Investment by
Higher interest rates on corporate bonds or bank loans will make it more expensive for firms to borrow resulting in less investment to different projects. That's because firms typically use borrowing from financial markets or from banks to investment in buildings, machinery, equipment, etc. Keep in mind: lower interest rates can make firms want to invest more into stocks which would then increase their investment spending.
How Interest Rates Affect Exports
Interest rates rise in U.S.: investors from other countries like our financial assets (our bonds) -Increase in demand for U.S. bond: increases demand for U.S. dollars in foreign exchange markets. -Increase in demand for dollars makes dollar "stronger" compared with other currencies. -When dollar is "stronger" we buy more imports. (our dollar goes further buying foreign goods.) -We buy more imports, AD shifts left (because when M increases, X-M decreases.) -Therefore, when interest rates go UP in the U.S. AD decreases; and when interest rates go DOWN in the U.S. AD increases
Countercyclical policy
Meant to reduce the severity of the business cycle and which is what the Fed intends to use
Employment Act of 1946
Responsibility of the Federal Government to foster and to promote conditions under which there will be afforded useful employment, for those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power." Because price stability and high employment are explicitly mentioned in the Employment Act, it is sometimes said that the Fed has a "dual mandate" to attain these two goals.
When the fed decreases the money supply
Supply curve shifts left and the equilibrium interest rate rises
Interest Rates go down then Supply of money (vertical line) shift? and quantity of money (the horizontal axis) will be?
Supply of money line shift right Quantity of demand will go higher (to the right) because more people will demand quantity of money
Monetary Policy Targets
That i can affect directly and that, in turn, affect variables, such as real GDP, employment, and the price level, that are closely related to the Fed's policy goals The two main monetary policy targets are the money supply and the interest rate. The fed typically uses the interest rate as its policy target.
Fed and what it can and cannot control
The Fed controls the money supply but it DOES NOT control money demand.
Federal Funds Rate
The interest rate banks charge each other of loans in the federal funds market. The loans are usually very short-term , often just overnight. Fed does NOT set the Federal Funds Rate
Second model of interest rate: Short term nominal rate of interest
When analyzing monetary policy economists focus on the short-term nominal interest rate because it is the interest rate most affected by increases and decreases in the money supply.
Inflation targeting
a central bank publicly sets an explicit target for the inflation rate over a period of time, and the government and the public then judge the performance of the central bank on the basis of its success in hitting the target.
An increase in the price level
increases the quantity of money demanded at each interest rate, shifting the money demand curve to the right.
Credit Default Swaps
• It was like insurance on one of these mortgage-based securities • Credit default swap was simply a bet • If you bought one, you were betting that people wouldn't default on their mortgages • If you bought one, you were betting there that people might default • So you were covering yourself • Derivative security
Changes to the interest rate will only affect these 3 variables for Aggregate Demand
1.) Consumption 2.) Investment 3.) Net Exports.
How Interest Rates Affect Aggregate Demand
1.) Consumption When rates are lower people more likely to buy cars, furniture, etc. -also when rates are low, people like to save less and spend more
Four monetary policy goals that the Fed has:
1.) Price stability 2.) High employment 3.) Stability of financial markets and institutions 4.) Economic growth
The Money Market
1.) Demand for Money: is Downward sloping 2.) Supply of Money: is the vertical line 3.) Increase Money Supply: Interest rates fall 4.) Decrease Money Supply: Interest Rates Rise
3 Levels of Risk with Credit Default Swap:
1.) Initital mortgages themselves, which eventually went bad 2.) 2.) the bonds (or mortage-backed securities) based on the mortgages which eventually went bad 3.) The credit default swaps, the insurance (or bets) which eventually
How Interest Rates Affect Aggregate Demand
1.) Investment: -When rates are lower firms will borrow more to undertake new projects, purchase new equipment -When borrowing costs are lower, "break-even" point on new projects reached more easily.
The role of credit
1.) businesses, large or small, all operte on credit 2.) Employees have to be paid weekly, supplies needed daily, bu clients often only pay their bills quarterly 3.) During the "in-between" companies mantain loans or lines-of credit.
Securitization
Mortgage back securities (MBS) Asset Back Securities (ABS) Collateralize Debt Obligations (CDO)
The money demand curve slopes downwards because
lower interest rates cause households and firms to switch from financial assets to money. All other things being equal, a fall in the interest rate from 4 to 3 percent will increase the quantity of money demand to the right. An increase in the interest rate will decrease the quantity of money demanded. Shift left
How the Fed Measures Inflation
Fed uses PART of GDP Deflator called "Personal Consumption Expenditure" Price Index or PCE PE is just the "C" part of GDP After 2004: CORE pce index measures removes food prices and gas prices Because: -Food and Energy prices more volatile than rest of "C" in GDP -Core PCE index gives more consistent reading -"Fed wants to track "persistent" inflation" -Problem: Food and energy are 2 of 3 largest components of HH expenditures.
When interest rates rise they will affect AG Net Exports by
If interest rates for the U.S. dollar rises compared to interest rates of other countries, this will result to investing more into U.S. financial assets. Causing foreign investors to increase THEIR demand for dollars which will increase the value of the U.S. dollar.
-Contractionary Monetary Policy
Money supply goes down or Interest rates go up; AD SHIFTS LEFT The Federal Reserve's policy of increasing interest rates to reduce inflation.
Expansionary Monetary
The Federal Reserve increasing the money supply and decreasing interest rates. Allows the Fed to reach it's goal of high employment Money supply goes up or Interest rates go down; AD shifts RIGHT
Monetary Policy
The actions the Federal Reserve takes to manage the money supply and interest rates to achieve macroeconomic policy goals.
TARP (Trouble Asset Relief Program) "The Bailout"
The bailout is NOT the stimulus; The Stimulus is Not the The Bailout TARP signed by PResident Bush in 2008 Allowed the treasury and the fed to purchase "toxic assets" from large banks Intent: get them to start making loans again, upstop the credit markets up to 700 billion
The effect of the Interest Rate When the Fed INCREASES the money supply:
When the Fed increases the money supply, households and firms will initially hold more money than they want, relative to other financial assets. Households and firms use the money they don't want to hold to buy treasury bills and make deposits in interest-paying bank accounts. This increase in demand allows banks and sellers of Treasury bills and similar securities to offer lower interest rates, Eventually, interest rates will fall enough that households and firms will be willing to hold the additional money the Fed has created.
How interest rates affect AG Net Exports
When the value of the dollar rises, households and firms in foreign countries will be willing to buy more goods and services produced from the U.S. and households and firms in the U.S. will pay less for goods and services from foreign countries. -This will result in the U.S. exporting less and importing more.
Money Market
brings together the demand and supply for money. Interest rate is on the vertical axis quantity of money is on the horizontal axis Uses M1 definition of money (equals currency plus checking account deposits). Demand curve is downward sloping because: Households and firms have a choice between holding money and holding other financial assets, such as U.S. treasury bills. In making the choice, households and firms take into account that: -Money has one particularly desirable characteristic: you can use it to buy goods, services, or financial assets. -Money also has one undesirable characteristic: It earns either a zero interest rate or a very low interest rate.