Midterm 2 Flashcards
Phillips Curve, U & π
US SRPC shifted outward 1953-1983, was highest 1979-83.
US SRPC moved back down 1983-2008.
SRPC shifts when π^e shifts (π^e is the intercept of SRPC & LRPC)
U_N varies with U benefit:
Normally <= 26 weeks
Up to 99 weeks 2009-2012, back to normal 2013
SRPC Tradeoff & M policy
Inflationary M policy: M ↑, M/P > m^d, π>π^e; by Walras’ Law, excess on money supply =excess in demand of real goods, D↑, Q↑, U↓, U_N (not changed by M policy), unchanged because M policy must be neutral on average.
Slope of SRPC: trade off between π-π^e & U-U_N
Adaptive Learning & Rational Expectations
Adaptive Learning: when P=M/m^d, π^e drives π. Targeting U* < U is feasible, results in accelerated π, (Accelerate Hypothesis)
Rational Expectations: π^e is not dependent on past π, π^e adjusts immediately if M increases or decreases.
Official M1, M1-S, M2 Pre 2020
Official M1 before 2020=Currency in circulation +checkable deposits (exclude Sweep Accts)
M1-S=Currency in circulation+Checkable Deposits (include Sweep Accts)
M2=M1+Saving Deposits (including MMDA)+Small Time Deposits (CDs)+Retail MMMFs
Official M1, M1-S, M2 post 2020
New M1=Currency in circulation+Demand deposits+Other Liquid Deposits (Savings, NOWs, Sweeps, MMDAs, 66% of new M1)
M2=M1+Savings Deposits (including MMDA)+small time deposits(CDs)+Retail MMMFs (same)
Type of Bank Deposit: Demand Deposits. Money Aggregate?
M1
Type of Bank Deposit: Saving Accts. Money Aggregate?
M2, not in M1 until 2020
Type of Bank Deposit: Large/Negotiable CDs (>=$100k). Money Aggregate?
Never in M1 or M2
Type of Bank Deposit: Small CDs. Money Aggregate?
M2
Type of Bank Deposit: NOW accounts (negotiable order of withdrawal). Money Aggregate?
M1 since checkable
Type of Bank Deposit: MMDAs (Money market deposit accounts). Money Aggregate?
M2, not in M1 until 2020
Type of Bank Deposit: Sweep Accts. Money Aggregate?
M2, not in M1 until 2020
Comercial Bank Balance Sheet
CB assets:
- Cash Assets
- Debt Securities:
- Corporate Bonds
- State and local bonds
- Real estate loans
- Consumer loans
- Commercial and industrial loans
CB Liabilities:
- Demand Deposits
- Other liquid Deposits (51% of total liabilities)(M1)
- Small TDs (M2)
- Large TDs
- Borrowings
- Net Worth=A-L
Prime Rate vs 3 month T bill
Prime Rate: the rate banks charge their largest and most creditworthy customers
Since 1990, prime rate =~ 3 month T-Bill rate +3.25%
Fed Fund Market and FDIC
Discount rate: the rate the fed lends directly to banks
Fed Fund Rate: the rate banks charge each other for short term fund; =~ 3 month T Bill rate
Fed Fund Market: allows banks with surplus reserves to lend to banks with shortage of reserves
FDIC Insures depositor to $100k pre 2008, to $250k/depositor since 2008
Brokered Deposits take your $10M & place in 40 banks paying high interest; this circumvents limit of insurance per depositor set by FDIC
The Money Supply
M=C+D
B=C+R
M=kB
k=(c+1)/(c+f), c=currency/checkable deposits, f=reserves/checkable deposits
c↑, f remains constant, k↓
c↓, f remains constant, k↑
Sweep Account
Sweep adjusted c experienced a great increase 1955-2007 due to the surge of underground economy
Sweep grew rapidly after 1995 but since accounts were converted official M1 & M1-S understated
Reserve Requirement by Fed: Checking: $0-$14.5M
Discretionary Range: 0%
2015: 0%
3/22/20: 0%
Reserve Requirement by Fed: Checking: $14.5M-$103.6M
Discretionary Range: 3%
2015: 3%
3/22/20: 0%
Reserve Requirement by Fed: Checking: $103.6M and up
Discretionary Range: 8-14%
2015: 10%
3/22/20: 0%
Reserve Requirement by Fed: Savings, Time & MMDA
Discretionary Range: 0-9%
2015: 0%
3/22/20: 0%
Traditional Base Equation
B=S+L+I+C-D-NW
S: securities L: net loans I: international Reserves C: treasury currency (coin) D: other deposits
Source of Base: Securities S
Fed sets B via OMO:
Open market sale: S↓, B↓ ⇒ P_bond ↓, yield ↑
Open market purchase: S↑, B↑ ⇒ P_bond↑, yield ↓
Or Fed sets yield via P_bond
Not both
Interest on Reserve
Before 10/08, Fed paid no interest on reserves
Banks rushed to lend out excess reserves
Quintupling base would have quintupled M, P
Since 10/08, Fed has paid interest on both required and excess reserves at slightly over FFR
IORR=Interest on Required Reserves
IOER=Interest on Excess Reserves
IOER means banks are content to hold excess reserves, are in no rush to make new loans to public, so IOER has neutralized otherwise stimulative effect of M policy
One-time change in nominal money stock
One time decrease in M
Nominal interest rate to increase in SR, return to original value in LR (μ_0=π^e=0, i=r)
Real interest rate to increase in SR, return to original value in LR
permanent change in nominal money stock
Permanent decrease in M
Nominal interest rate to increase in SR, decrease in LR (i=r_N+μ_0, μ_0<0)
Real Interest rate to increase in SR, return to original value in LR
Benchmark Taylor Rule
i=1.0+1.5π+0.5ygap
i:Fed Fund Rate target, equilibrium real interest rate
π : last 12 month average inflation
Ygap: % deviation of y from trendline
Derived from strong inflation feedback: i=r+π+a(π-π*)
Effective Fund Rate
Peak 1980 =~ 19%
Low in 2009-2015 <=0.25%
Forward Interest Rate
f(m,m+1)=(m+1) y(m+1) - m y(m)
y(m+1)=((m y(m)+f(m,m+1))/(m+1))
Zero Lower Bound
If i* goes below 0, Fed can set y(m)=0 for some m below the normal 1/8 year (temporarily move into maturities greater than 1/8 year).
(stimulus %)(1/8)=(% below r)*m
If the FOMC only meets 8 times a year and always leaves its FFR target i* in place until the next meeting, it is effectively forcing interest rates y(m) to equal its target out to maturity m=⅛ year, and not directly intervening in the yield curve beyond that maturity.
Friedman and Schwartz
The potentially long and variable gap between when a situation arises that calls for monetary stabilization policy and when the policy actually has its effect will tend to destabilize output and employment. Best to just stabilize P, π with M policy, let y, U take car of themselves.
Paul Krugman: failure to provide easy M policy when inflation is on target (unnecessary restrictive M policy) constitutes “Sado-Monetarism”
Liquidity Premium
Forward rates>corresponding future short rates
r_long maturity>r_short maturity, longer maturity bonds have higher one period returns on average than short term one period returns.
Inside and outside lag
Recognition Lag:
Time it takes to recognize a problem exists
EX: The time between the midpoint of a quarter and when an accurate GDP figure is available for that quarter
Decision Lag:
Time it takes to decide what to do about problem once it has been recognized
Implementation Lag:
Time it takes to implement policy once it has been decided upon
The FOMC’s practice of ordinarily only changing its FFR target by 25 basis points at a time, rather than immediately moving it to the rate actually called for by its policy rule
Outside lag:
The time it takes change in policy instrument to affect economy, outside policy process
