Monetary Policy the “Fed” Alan Greenspan
Remember, our goal is to keep the aggregate demand curve (AD) stable and intersecting the short-run aggregate supply curve (SRAS) at full employment (FE). This is where the economy operates at its most efficient potential.
Peak Ex pa ns io n Peak on on tii ct ac ra tr on o C C GDPr per year Trough Time
To stabilize the economy. Federal Reserve carries out monetary policy. Monetary policy; the deliberate changes in the money supply to influence interest rates and thus the total le of spending in the economy. Only “fiscal or monetary policy can get me back on my feet and allow “Sam” to get back up u
When the economy is not partying at all (recession), the Fed job is to “spike the punch. ”
Tools Of Monetary Policy
Open-Market Operations during a recession
RR - Atomic Bomb of Monetary Policy
Atomic Bomb of Monetary Policy Suppose the banking system has $500 billion in DD. The RR is 12% & AR are$60 billion There areno ER. in this system, thus no new loans can be made (500 x. 12 = 60). Now, what if the Fed lowers the RR to 10%, hat w would be the affect on the banking system?
Atomic Bomb of Monetary Policy
3. The Discount Rate - The interest rate that the Federal Reserve charges commercial banks for emergency loans
Discount Rate: When the Fed provides loans to commercial banks, 100% of those funds are excess reserves (not subject to the reserve ratio). Banks can loan out all of these funds.
A lowering of the discount rate encourages commercial banks to increase excess reserves by borrowing from the Fed. These excess reserves are then loaned out and increases the money supply.
Easy money Policy: When the economy faces a recession the Fed will decide to increase the money supply, called easy money policy.
Money Market RIR MS 1 MS 2 Investment Demand DI RIR DM AS/AD Pl AD 1 AD 2 AS QID 1 QID 2 Qm Qm P 2 P 1 Q* Buy Bonds MS I. R. QID AD Y/Emp/ PL
Tight money Policy: When the economy is suffering from inflationary pressures the Fed will decide to decrease the money supply, called tight money policy.
Investment Demand Money Market RIR Dm MS 2 MS 1 Price level AS/AD P 1 AD 2 AS AD 1 RIR Qm Di QID 2 QID 1 Qm P 2 Q* Sell Bonds MS I. R. QID AD Y/E mpl. /PL
Strengths of Monetary Polic 1. Speed and flexibility –Compared to fiscal policy monetary policy can be quickly altered. The buying & selling of bonds can occur on a daily basis. 2. Isolation from political pressures – because the Board of Governors serve 14 year terms. They can enact unpopular policies which might get a member of Congress fired, but is best for our economy’s health. 3. Success since the 1980 s a tight money – policy helped bring inflation from 13. 5% in 1980 to 3. 2% in 1983. An easy money policy helped the economy recover from the 2000 recession.
The End
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