mt3

monetary targeting

Central bank announces annual growth rate of monetary aggregates. Enhances the transparency of monetary policy and the accountability of the central bank. Less emphasized to to free fed's hand to manipulate interest rates and thereby fight inflation

Monetary Base

Currency + Reserves

overnight cash rate

ECB interest rate for very​ short-term interbank​ loans

Things that Increase Money Supply

Increases in liabilities, govt securities, the monetary base, reserves, and loans to banks

Money Multiplier

M = (1+r)/(r+e+c) * (MBn + BR)

management of expectations

commitment to keep short-term rates aimed at lowering long-term interest rates and also raising inflation expectations, thereby reducing the real interest rates.

Money Supply

C+D = m*MB

Market for reserve yields

when the central bank makes an open market purchase or lowers reserve requirements, the overnight interbank interest rate declines. When the central bank makesan open market sale or raises reserve requirements, the overnight rate rises.

Disadvantages of inflation targeting

1. Delayed signalling - inflation outcomes are revealed only after a substantial lag and not easily controlled by monetary policy. 2. Too much rigidity - imposes a rigid rule on monetary policymakers and limits their ability to respond to unforeseen circumstances 3. Potential for increased output fluctuations - sole focus on inflation may lead to monetary policy that is too tight when inflation is above target and thus may lead to larger output fluctuations. (set rates above 0) 4. Lead to low economic growth in output and employment

Advantages of the​ Fed's "just do​ it" approach​

1. its​ forward-looking behavior and stress on price stability that help to discourage overly expansionary monetary​ policy, thereby ameliorating the​ time-inconsistency problem. 2. it does not rely on a stable​ money-inflation relationship.

The​ risk-channel of monetary policy

A monetary policy reaction function that responds to movements in bank leverage or to movements in credit spreads can incentivize banks to increase their use of debt finance and increase leverage, ceteris paribus, increasing the riskiness of the financial sector for the real economy A.is propagated by low interest rates from overly easy monetary policy. B.suggests that monetary policy should be used to lean against credit bubbles. C.is caused by the incentives for asset managers to search for yield. greenspan doctrine: advocates that monetary policymakers respond to​ asset-price bubbles only insofar as it affects its price stability and output objectives.

nominal anchor

A nominal anchor is a nominal variable such as the inflation​ rate, the money​ supply, and the exchange​ rate, which ties down the price​ level, keeping the nominal variable within a narrow range in order to achieve price stability.

inflation target > 0

1. monetary policymakers are concerned that particularly low inflation can have substantial negative effects on real economic activity. Deflation (negative inflation in which the price level actually falls) is especially to be feared because of the possibility that it may promote financial instability and precipitate a severe economic contraction 2. reflects the importance of real wage flexibility as an adjustment mechanism. An inflation rate of zero may prevent necessary adjustment processes in labour markets, thereby hampering the efficient allocation of resources in the economy. Provides seignorage revenue to the gov. (including inflation tax on the underground economy and foreign USD holdings)

Multiple Deposit Creation

Change in Deposits = 1/r * Change in Reserves

"Lean vs. clean" debate

Key issue: whether leverage (debt) accompanies financial imbalance (stock price bubble in 1990s vs. house price bubble in the 2000s) •consensus view: MP as "last line of defense" even when financial imbalances features leverage- Is monetary policy effective to address financial imbalances? -There are more "targeted" tools available to address financial imbalances that are sector-specific (such as bank capital regulations or regulatory loan-to-value ratio on mortgages). -using MP leaning only if financial imbalances are pervasive across different sectors, and/or MP itself is causing the imbalance

implicit nominal anchor

can raise interest rates to avoid signs of increased inflationary pressure to maintain stability adv: Does not rely on stable money-inflation relationship dis: low accountability, transparency, and success depends on fed chairman

forward guidance

central bank's announcements today about future policy target rates Primary intent is tolower the term structure of interest ratesbased on expectations of future rates. e.g., "exceptionally low levels...as long as unemployment > 6.5%, inflation < 2.5%"

advantage of quantitative easing when​ short-term interest rates are at the zero​ lower-bound

Purchases of longer−term securities could reduce longer−term interest rates and hence lead to an expansion. Since​ short-term interest rates cannot be lowered below the zero​ lower-bound in this​ environment, conventional monetary policy would be ineffective.​ Thus, the main advantage of quantitative easing is that purchases of intermediate and​ longer-term securities could reduce​ longer-term interest​ rates, thus increasing the money supply further and leading to an expansion.

marginal lending rate

Rate at which European Monetary Union can borrow​ (against eligible​ collateral) overnight loans from national central banks

Credit-driven bubbles are​ ____ to identify and pose a​ ____threat to the financial system compared to bubbles driven solely by irrational exuberance.

easier; larger appropriate policy is macroprudential regulation (lean vs clean)

decline in reserve requirements

expansion of the money supply and a fall in the overnight market rate.

MP goals

high employment, stability in FX & financial mkts, stable pricing

taylor rule

interest rate target = inflation rate + equilibrium real interest rate + (1/2)(inflation gap) + (1/2)(output gap) if economy experiences prolonged increases in productivity growth while actual output growth unchanged, Taylor rule implies policymakes should decrease fed funds rate because potential output would increase and the output gap would decrease The principle that the monetary authorities should raise nominal interest rates by more than the increase in the inflation rate has been named the Taylor principle, and it is critical to the success of monetary policy disadv: The Taylor rule​ doesn't take into account the possibility of a wide variation in forecasts, not good for strict interpretations

Inflation targeting

involves several elements: (1) public announcement of medium term targets for inflation; (2) an institutional commitment to price stability as the primary, long-run goal of monetary policy and a commitment to achieve the inflation goal; (3) an information-inclusive approach in which many variables (not just monetary aggregates) are used in making decisions about monetary policy; (4) increasedtransparency of the monetary policy strategy through communication with the public and the markets about the plans and objectives of monetary policymakers; and (5) increased accountability of the central bank for attaining its inflation objectives.

credit easing

the central bank aims at shifting the composition of the balance sheet from risk-free assets (like Treasury bills) towards risky assets (like mortgage backed securities). trying to prop up equity markets by actively purchasing shares of stocks on the open market. During the years after the financial crisis, central banks around the world did in fact engage in equity markets to some degree. different then QE--affects composition rather than size

QE

the focus of policy is the quantity of bank reserves, which are liabilities of the central bank, and the composition of lending and securities on the asset side of the central bank's balance sheet is incidental

NAIRU

the nonaccelerating inflation rate of​ unemployment, is the rate of unemployment at which there is no tendency for inflation to change.

Banks expect an unusually large increase in withdrawals from checking deposit accounts in the future.

they will want to hold more excess reserves today, meaning the demand for reserves will increase at any given interest rate. If the federal funds rate is initially below the discount rate,this then leads to a rise in the federal funds rate. Borrowed reserves and nonborrowed reserves do not change. If the federal funds rate is initially at the discount rate, then the federal funds rate will just remain at the discount rate, but borrowed reserves will increase.

Liquidity provision

unprecedented increases in its lending facilities to provide liquidity to the financial markets -discount window expansion (but stigma effect) -various new lending programs: Term Auction Facility (TAF) etc.

unconventional policy tools

want to prevent the risk of deflation. -management of expectations -credit easing -QE -Liquidity provision -Zero lower bound on Fed Funds Rate (liquidity trap, negative interest rates) -Term Auction Facility​ (TAF)

Fed's long-term goals and strategy

• statutory mandate from Congress -maximum employment, stable prices, moderate long-term interest rates •Inflation target: 2% (annual change in PCE deflator) -anchors long-term inflation expectations -fosters price stability and moderate long-term interest rates -enhances ability to promote employment mandate (through flexible inflation targeting) •Maximum employment -no long-run target as determined by non-monetary factors -latest estimate for natural rate of unemployment: 4.8% •Dual mandate -balanced approach for inflation gap and employment gap

benefits of repurchase agreement when float decreases below normal level

(conventional) Because the decrease in float is​ temporary, the monetary base is expected to decline only temporarily. A repurchase agreement only temporarily injects reserves into the banking​ system, so it is a sensible way of counteracting the temporary decline in the monetary base due to the decline in float. Repurchase agreements are used more often for defensive operations. Repurchase agreements can be easily counteracted if the float changes again. Repurchase agreements are temporary in their time frame.

adjusting discount rate

(conventional) affects the level of borrowed reserves. *advantage: helps prevent bank failure from spreading *disadvantage: Banks that deserve to go out of business due to poor management may survive because of Fed discounting to prevent bank panics. the fed could alternatively affect the level of borrowed reserves by directly limiting the amount of loans to an individual bank or the broader financial system. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy, not necessarily for expansionary reasons

Dynamic open market operations

(conventional) used to change policy or create movements in the money supply. by changing the level of reserves and the monetary base.

reverse repos

(convtl) allows fed to reduce its large asset holdings in clean fashion while reducing future inflationary problems. Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to reduce its balance​ sheet, thus decreasing the money supply and raising​ short-term interest rates.

Defensive open market operations

(convtl) intended to offset movements in other factors that affect reserves and the monetary base Because most open market operations are typically repurchase​ agreements, it is likely that the volume of defensive open market operations is greater than the volume of dynamic open market operations.

composition of Fed's balance sheet

(unconv) During a crisis, Fed can influence interest rates and provide more targeted liquidity. Fed purchased a significant amount of​ mortgage-backed securities from​ government-sponsored enterprises, which helped to lower mortgage rates and support the housing market.

unconditional policy​ commitment

(unconv) The main advantage to an unconditional policy commitment is that it provides a significant amount of transparency and​ certainty, which makes it easier for markets and households to make decisions about the future. An unconditional policy commitment does not suggest that the commitment will be abandoned and so is likely to have a larger effect on​ long-term interest rates than a conditional one.

term auction facility

(unconv) used by financial institutions than the discount window during the global financial​ crisis bcuz interest rate on these loans were less than discount rate and avoid discount window stigma The Term Auction Facility proved to be more widely used because the interest rate on these loans was set through a competitive​ process, and that interest rate was less​ (in some cases much​ less) than the discount rate. In​ addition, because of the structure of the Term Auction​ Facility, there was some anonymity for banks that were accessing these​ funds, which helped to avoid the stigma associated with discount window lending.The Term Auction Facility proved to be more widely used because the interest rate on these loans was set through a competitive​ process, and that interest rate was less​ (in some cases much​ less) than the discount rate. In​ addition, because of the structure of the Term Auction​ Facility, there was some anonymity for banks that were accessing these​ funds, which helped to avoid the stigma associated with discount window lending.

advantage of inflation targeting

--With inflation targeting, stability in the relationship between money and inflation is not critical to its success, because it does not rely on this relationship. An inflation target allows the monetary authorities to use all available information, not just one variable, to determine the best settings for monetary policy. --it is readily understood by the public and is thus highly transparent --reduce the likelihood that the central bank will fall into the time-inconsistency trap of trying to expand output and employment in the short run by pursuing overly expansionary monetary policy

nominal anchor benefits

-limit the​ time inconsistency problem by providing an expected constraint on monetary policy. -provides a direct measure to see if the central bank is achieving its goal. -helps promote price stability by tying inflation expectations to low levels directly through its constraint on the value of money.

conventional policies

-provide discount loans to troubled banks to keep bank failures from spreading -setting target for fed funds rate through OMO -repurchase agreements -paying interest on reserves - allows the Fed to increase its lending as much as it wants without reducing the federal funds rate. -Dynamic & defensive open market operations -reverse repos

long-run goals of the Federal Reserve based on its statutory mandate

The Fed's statutory mandate from the Congress refers to promoting maximum employment, stable prices, and moderate long-term interest rates. As long-run inflation is primarily determined by monetary policy, the Fed can specify a long-run goal for inflation, which is currently set at 2%, as measured by the annual change in the price index for personal consumption expenditures. This inflation target helps anchor long-term inflation expectations, thereby fostering price stability and moderate long-term interest rates, and enhances the Fed's ability to promote maximum employment in the face of significant economic shocks.

Fed's strategy is to achieve long-term goals

The maximum level of employment is largely determined by nonmonetary factors (such as the structure and dynamics in the labor market); thus, the Fed does not specify a fixed goal for employment (or unemployment rate), but tries to close its assessed output gap (and therefore unemployment gap) in the medium term along with the deviation of actual inflation from its target. With demand shocks, the Fed does not generally face a trade-off since its inflation and employment objectives can be reached in complementary fashion (i.e., raising interest rates would reduce both inflation and output gap, while lowering interest rates would increase both inflation and output gap). Under circumstances in which the Fed faces a trade-off in terms of stabilizing inflation versus employment, it follows a balanced approach in promoting them given its "dual mandate".

switch from deposits into currency

The switch from deposits into currency lowers the amount of reserves and this lowers the supply of reserves at any given interest​ rate, thus shifting the supply curve to the left. The fall in deposits also leads to lower required reserves and hence a shift in the demand curve to the left However, because the fall in required reserves is only a fraction of the fall in the supply of reserves​ (because the required reserve ratio is much less than​ one), the supply curve shifts to the left by more than the demand curve.​ Thus the federal funds rate​ (which is initially below the discount​ rate) will rise.

lean vs clean" debate regarding the monetary policy's role in dealing with various financial imbalances (such as stock price bubbles or unsustainable levels of household debt and bank leverage)

lean on debt (keep interest rates higher by taylor rule), clean on exuberance (keep interest rates low to clean up mess) When financial imbalances develop, the Fed can try to "lean" against these imbalances by keeping interest rates higher than what they should be (e.g., interest rate that would be implied by a "Taylor rule" that depends only on inflation and output gap objectives). Monetary leaning can thus curb or slow down the rise in asset prices and debt/leverage accumulation. Alternatively, the Fed could wait until a financial disruption occurs as a result of the imbalance, and try to "clean" up afterwards by lowering interest rates and not letting the economy fall into a deep recession. The key issue for the appropriate response seems to be whether leverage (i.e., debt) accompanies the financial imbalance or not. The stock market crash in 2001 had minor implications for the economy since stock purchases were not driven by debt, while the house price crash in the 2000s had major adverse consequences on the economy as households and banks had to delever (i.e., reduce debt) after the crisis, lowering the impact of monetary policy. The above discussion suggests that monetary policy leaning, if used, should be used only when debt accompanies the financial imbalance. The consensus view among many economists however is that monetary policy leaning is not very effective to curb debt, unless the central bank is willing to raise rates a lot, with significant adverse consequences to the economy. Hence, monetary policy leaning should be used sparingly, and only as a "last line of defense" against financial imbalances. Other, more "targeted" tools (such as raising bank capital regulations or the regulatory loan-to-value ratio on mortgages) should be the tools of choice to curb financial excess.

dual mandate problem

policies that increase output and employment in the short run can create excessive inflation in the long run

federal funds rate

setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis. It meets its target through open market operations, financial transactions traditionally involving U.S. Treasury securities