5.05: Monetary Policy

Question 1

Monetary Policy

Answer 1

Central Bank’s use of the MS to stabilize the economy in times of a recession and an inflationary period

Question 2

What is the dif. between monetary policy and fiscal policy?

Answer 2

Monetary policy: Changes to MS by fed
Fiscal policy: Taxes and Spending by Congress

Question 3

Old School vs New School

Answer 3

Traditionally monetary policy in the US has operated under a limited reserves framework

Since 2008 monetary policy in the US has operated under an ample reserves framework

Question 4

In a limited reserve framework banks:

Answer 4

Hold RR and try to limit their ER.

If they are unable to meet the RR they can: call in loans, sell assets, borrow from the central bank, and borrow from other commercial banks

Question 5

Federal Funds Rate Target

Answer 5

• When banks are short on RR they borrow from each other overnight
• The Fed Funds Rate is the interest rate that banks charge each other for overnight loans
• The fed funds rate is a signal for interest rates throughout the entire economy
  
  • If the Fed funds rate is low, businesses loan rates and mortgage rates will be low too
  • If the fed funds rate is high, business loan rates and mortgage rates will be high too
• The Fed uses federal funds rate as its Policy Rate

Question 6

Why must the Fed only “target” the federal funds rate?

Answer 6

B/c the Fed doesn’t directly set the fed funds rate

Question 7

Reasons consumers might need to borrow money + pay interest:

Answer 7

Mortgages, start-up businesses, cars, student loans, big purchases, and capital goods

Question 8

If interest rates dec,

Answer 8

Interest-sensitive consumption and investment will increase and AD will increase

Question 9

If interest rates inc,

Answer 9

interest-sensitive consumption and investment will decrease and AD will decrease

Question 10

What determines interest rates? What does the Fed control?

Answer 10

The MS determines interest rates; the Fed controls it.

Question 11

To increase AD, the fed must

Answer 11

inc MS

Question 12

To decrease AD, the fed must

Answer 12

dec MS

Question 13

Discount Rate

Answer 13

Rate at which the Fed will lend to commercial banks

• At the end of the day banks need to have the right amount of RR. If the ank is short, it must borrow money
• The discount rate is the interest rate that the Fed will lend to commercial banks for borrowing money if banks cannot find another bank to borrow from
• B/c of the discount rate, the Fed is the lender of last resort

Question 14

Open Market Operations

Answer 14

• When the Fed buys or sells gov bonds (securities) to target the Fed Funds rate
• This is the most important and widely used monetary policy bc it allows the Fed to directly inc and dec the MS

Question 15

Expansionary/Loose Monetary Policies

Answer 15

Decrease reserve requirement, decrease discount rate, buy bonds

Question 16

Contractionary/Tight Monetary Policies

Answer 16

Increase reserve requirement, increase discount rate, sell bonds

Question 17

Nominal interest rates

Answer 17

The interest rate not adjusted for inflation. This is the issued rate on loans

Question 18

Real Interest Rates

Answer 18

The interest rate adjusted for inflation

Question 19

Real interest rate

Answer 19

NIR - Inflation