Activity 40

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Activity 40

• Monetary Policy

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1. What is monetary policy?
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• 1. What is monetary policy?

• Central bank activities to
• Promote growth
• Stabilize prices
• Maximize employment
• Moderate long-term interest rates
• Actions by the Fed to increase or decrease the
  money supply, to influence the economy

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2. From 1998 to 2002, what was the dominant focus
of monetary policy and why?
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• 2. From 1998 to 2002, what was the dominant focus
  of monetary policy and why?

• From 1998 to 2001, the Fed wanted to slow growth
  to prevent inflation
• From 2001on the Fed wanted to stimulate growth
  without stimulating inflation

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3. Explain why the money supply and short-term
interest rates are inversely related.
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• 3. Explain why the money supply and short-term
  interest rates are inversely related.
• Money supply is money supply, regardless of the
  interest rate it is perfectly inelastic because
  it is controlled by the Fed.
• However changes in the money supply and
  short-term (nominal interest rates) are inversely
  related

• When the Fed buys securities (to increase the
  money supply) banks have more checkable deposits
  and therefore more reserves. Banks lower rates
  to entice more customers
• Easy money policy lowers the nominal interest
  rate
• When the Fed sells securities (to decrease the
  money supply) banks have fewer checkable deposits
  and therefore fewer reserves. Banks raise rates
  because they have fewer customers
• Tight money policy raises the nominal interest
  rate

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4. What are some reasons for lags and
imperfections in data used by central banks?
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• 4. What are some reasons for lags and
  imperfections in data used by central banks?

• Financial institutions report at specified times
  (ie quarterly to stockholders) and this may not
  be when the Fed may necessarily needs the
  information most.
• The central bank collects data from samples and
  extrapolates, errors can be in the data

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5. Why do many economists believe that central
banks have more control over the price level than
over real output?
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• 5. Why do many economists believe that central
  banks have more control over the price level than
  over real output?

• Many believe real output is determined by the
  level of capital stock and worker productivity
• Thus money affects price level more than output
• The P in PQ rather than the Q

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6. What might cause velocity to change?
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• 6. What might cause velocity to change?

• Changes in how money is transferred
• Changes in interest rates
• Higher interest rates tends to increase velocity
• Changes in price level
• Higher price level tends to increase velocity

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7. If velocity were extremely volatile, why would
this complicate the job of making monetary policy?
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• 7. If velocity were extremely volatile, why would
  this complicate the job of making monetary policy?

• Change in Money supply affects price level in
  predictable ways if velocity is constant
• If velocity is volatile a change in money supply
  may be too small (not helping) or too large
  (leading to inflation)

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8. What role does the money multiplier (deposit
expansion multiplier) play in enabling the Fed to
conduct monetary policy?
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• 8. What role does the money multiplier (deposit
  expansion multiplier) play in enabling the Fed to
  conduct monetary policy?

• The multiplier (the reciprocal of the reserve
  requirement) times excess reserves,yields changes
  in the money supply

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9. What is the fed funds rate?
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• 9. What is the fed funds rate?

• The interest rates banks (financial institutions)
  lend to other banks for short term borrowing
  (overnight loans from their excess reserves at
  their Fed account to anothers)

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10. What happens to the fed funds rate if the Fed
follows a contractionary (tight money) policy?
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• 10. What happens to the fed funds rate if the Fed
  follows a contractionary (tight money) policy?

• The federal funds rate increases

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11. What happens to the fed funds rate if the Fed
follows a expansionary (easy money) policy?
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• 11. What happens to the fed funds rate if the Fed
  follows a expansionary (easy money) policy?

• The federal funds rate decreases

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12. Why do observers pay close attention to the
federal funds rate?
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• 12. Why do observers pay close attention to the
  federal funds rate?

• It is a leading indicator (early indicator) of
  monetary policy and
• a forecast of the direction for other interest
  rates and
• for Fed assessment of the direction of the economy