Chapter 21 Flashcards
FOMC Directive
- Press release format
- General statement on fostering price stability and sustaining economic growth
- Statement of Fed funds target
- Usually includes statement about “bias”- higher or lower rates or neutral
Basic problems with Fed:
- Fed doesn’t control employment, growth, or prices directly
- Doesn’t control the money supply b/c public controls how much currency they hold
- Doesn’t control reserves b/c banks control how much they lend
2 Problems with reserve targeting
- Even if Fed could hit reserves target, it will not hit money supply target b/c little c and little e are leakages
- Velocity makes link between money and spending unreliable - Link between aggregates and economic activity is unpredictable and unreliable
Typical Fed 4 step Strategy
- set goals for GDP, inflation, unemployment
- Decide on appropriate levels of LT interest rates (monetary aggregates dimished b/c of velocity) these are intermediate targest
- To achieve these, goals set for Operating Targets: Fed funds rate (reserve aggregates)
- Use tools (OMO, discount rate & RR) to achieve operating targets
- Intermediate and operating targets may be aggregates or interest rates (currently rates) (pg. 404)
Reserves vs. Federal Funds targets: history - and problems in attempting to target both:
- Prior to 1979 Fed favored fed funds rate as target
- Between 1979-mid 1982 reserve aggregates were operating target b/c of inflation
- 1982 to present - Fed funds rate
- Problem with trying to target both is that you cannot simultaneously target aggregates and Fed funds rates. They both work differently under different conditions. Aggregates for real economy and interest rates for monetary economy.
** Desirability of aggregates vs. interest rates as intermediate targets:
- They are relatively controllable as opposed to interest rates targets. (want them to be)
- They are closely linked to ultimate goals. (must be)
Why are aggregates superior if disturbances emanate from real economy:
- aggregates fluctuate in the interest rate. Economy can be more stable when interest rates fluctuate. An increase in consumer spending will raise demand for reserves, increasing interest rates and this rise counters the rise in spending enforcing an automatic countercyclical monetary policy.
- Can be a jump in investment spending as well
- Monetarists-believe real sector is less stable than monetary so monetary aggregates policy
- Militin Friedman
Why interest rates likely superior if disturbances emanate from monetary economy
- when link between reserves and spending are weak the fluctuations in the interest rates won’t stabilize the economy. There is change in money demand or velocity. IR policy is preferable b/c it automatically acts countercyclically.
- most recent financial crisis in the financial sector
- Keynesians-monetary sector less stable than real sector, IR policy
- Current Policy
Taylor Rule
- explains the Feds interest rate policy
- FFRnom = 2.0% + AI + .5(AI-TI) + .5(GDPact - GDPfe)
- AI = actual inflation
- TI = target inflation
- GDPact = actual employment (actual GDP)
- GDPfe = full employment (potential GDP)
What is the problem with targeting BOTH reserve aggregates and Fed funds rate?
In general, they are not consistent, that is:
you cannot simultaneously target price (Fed funds rate) and quantity (reserves)
What happens when demand for loanable funds or reserves increases?
- If Fed targets Fed funds rate, it loses control of reserves
- If Fed targets reserves, it loses control of Fed funds rate
(figures 21.4 a&b in notes)
When are aggregates superior (1) and when are interest rates superior (2)?
- if most disturbances in real sector
2. if most disturbances in monetary sector
Why do monetarists support a monetary aggregates target policy?
b/c monetarists tend to believe that the REAL sector is less stable than the monetary sector, they tend to support a monetary aggregates target policy.
Why do Keynesians support an interest rate target policy?
b/c Keynesians tend to believe that the monetary sector (i.e. money demand or velocity) is less stable than the real sector, they tend to support an interest rate target policy.
Taylor rule captures that Fed:
- targets inflation and changes federal funds rate when inflation is above (below) Fed target
- targets real GDP and changes federal funds rate when real GDP is below (above) potential GDP
