Post on 27-Dec-2015
transcript
The Federal Reserve
The FED is the part of the government that determines & enacts monetary policy.
The Fed serves as the central bank for the United States.
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Central Bank Functions: It is the banks’ bank: it accepts deposits from
and makes loans to commercial banks. It acts as banker for the federal government. It controls the money supply. Performs certain regulatory functions for the
financial industry.
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Fed Policy Tools Reserve requirements
How much money a bank must keep on hand Discount rate
The rate the Fed lends money to banks Federal Funds Rate
The interest rate for inter-bank reserve loans – One bank to another
Open market operations Treasury buys & sells government bonds
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Reserve Requirements Legal reserves
The cash a bank holds in its vault plus its deposits at the Fed.
Excess reserves If the Fed lowers reserve requirements, banks
that hold excess reserves can increase lending. Such lending increases the money supply.
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Changing Interest Rates
By altering the money supply the Federal Reserve is able to affect the equilibrium rate of interest.
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Interest Rates & Spending Altering the money supply changes the
equilibrium rate of interest. This changes consumer, investor, government,
and net export spending.
Higher rates less spending & investment
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Open Market Operations The buying and selling of government bonds by the
Fed to control bank reserves, the fed funds rate, and the money supply.
The FOMC Buys bonds: Bonds are replaced by cash Money supply is increased.
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Monetary Stimulus The goal of monetary stimulus is to increase
aggregate demand with lower interest rates. Increases investing Increases larger-ticket consumption
The increase in investment will kick off multiplier effects
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Monetary Stimulus: Tools:
Increase the money supply. Reduce interest rates.
Both lead to increase in aggregate demand which leads to more jobs, etc…
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Monetary Restraint
To lessen inflationary pressures, the Fed will apply a policy of monetary restraint.
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Obstacles to Fed Intervention
1. Reluctant Lenders Banks themselves must expand the money
supply by making new loans. Banks may be unwilling to make new loans
because their returns are lower.
2. Low Expectations
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Obstacles to Fed Intervention
3. Liquidity Trap When interest rates are low, people may
decide to hold all the money they can get – waiting for opportunities to improve.
4. Global Money borrow money from foreigners
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Real vs. Nominal Interest
The real interest rate is: The nominal rate of interest minus anticipated
inflation rate.
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The Equation of Exchange MV = PQ
M = money supply V = velocity of circulation P = Prices of products sold Q = Quantity of products sold
▪ PxQ = nominal GDP
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Stable Velocity Monetarist believe velocity of money (V) is stable. –
change (M) will change spending Some monetarists claim that Q, as well as V, is stable. -
If true, changes in the money supply (M) would affect only prices (P).
A stable Q means that the quantity of goods produced is primarily dependent on production capacity, labor-market efficiency, and other structural forces leads to a “natural” rate of unemployment
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Fighting Unemployment
The Keynesian cure for unemployment is to expand M and lower interest rates.
Monetarists fear that an increase in M will lead to higher P.
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The Policy Levers
What Keynesians and Monetarists argue about is which of the policy levers – (M) or (V) – is likely to be effective in altering aggregate spending.
Monetarists point to the money supply (M) as the principal lever.
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Crowding Out If (V) is constant, changes in total spending can come
about only through changes in the money supply.
If the government raises taxes or borrows more money, it effectively crowds out consumers and investors who would otherwise be spending or borrowing.
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Keynesian Advice
Keynesians reject fixed money supply targets.
Keynesians advocate targeting interest rates, not the money supply.
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