Chapter 34: Monetary Policy

why teh Fed doesn't target 0% inflation

1. inflation greases the wheels of the labor market (cut wages w/o actually changing nominal wages) 2. the Fed can lower real interest rates by more when inflation is above 0% 3. 0% inflation target runs the risk of deflation 4. measured inflation may be overstated

tools the fed uses to influence the federal funds rate

1. pays interest to banks on excess revenues 2. borrows money overnight from financial institutions 3. lends directly through the discount window 4. buys and sells government bonds

FOMC questions

1. what are your forecasts for the US economy 2. what are the right-policy choices given the economic outlook 3. how should the Fed communicate its plans effectively to the public

central bank

a country's principal monetary authority

deflation

a generalized decrease in the overall price level

reserve requirements

a minimum amount of reserves that each bank must hold

inflation target

a publicly stated goal for the inflation rate (2%)

open market trading desk (the dest)

a trading desk at the New York Fed reserve bank where the Fed buys and sells government bonds

fed policy options: borrow money from banks, raise required reserve ration, raise interest rate on excess reserves, sell government bonds to bans

leads to banks borrowing at a higher interest rate, less borrowing, less investment leads to less hiring and lower prices, slows expansion

Fed policy options: lend money to banks, lower required reserve ration, lower interest rate on excess reserves, buy government bonds from banks

leads to banks borrowing at a lower interest rate; more borrowing; more investment leads to more hiring and higher prices, slows recession

forward guidance

providing info about future of monetary policy to influence market expectations of future interest rates

quantitative easing (QE)

purchasing a lot of longer-term government bonds and securities to lower long-term interest rates

floor framework

the Fed's approach of setting other interest rates to a lower bound on how low the federal funds rate will go

open market operations

the Fed's buying and selling of government bonds to influence federal funds rate

lender of last resort

the Fed's role as the lender that financial institutions turn to when they're having trouble getting loans

dual mandate

the Fed's two goals of stable prices and maximum sustainable employment

reserves

the cash banks need to keep on hand to make payments

zero lower bound

the constraint that nominal interest rates cannot be effectively set below zero

federal open market committee (FOMC)

the federal reserve committee that decides the US interest rates. Fed governors and district Fed bank presidents

discount rate

the interest rate on loans that the fed offers to banks through the discount window; creates upper bound

federal funds rate

the interest rate the Fed uses as its policy tool, which is the nominal interest rate that banks pay to borrow from each other overnight in the federal funds market

interest rate on excess reserves

the interest rate the fed pays to banks on reserves that are in excess of required reserves

monetary policy

the process of setting interest rates in an effort to influence economic conditions

neutral real interest rate

the real interest rate at which real GDP is equal to potential GDP, and hence the output gap is zero

fed rule of thumb

the recipe that describes how the Fed often sets the interest rate: federal funds rate - inflation = neutral interest rate + 1/2(inflation - 2%) + output gap

overnight reverse repurchase agreements

when the desk sells a government bond to a financial institution with an agreement to buy it back the next day at a higher price