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Monetary Policy. 1%?. 2%?. 1.5%?. The Fed. Janet Yellen. Easy (Expansionary) Monetary Policy. MS 1. D I. MS 2. Investment Demand. 8% 6% 4% 0. 8 4 0. nominal Interest Rate. 6%. D M. Buy. If there is a RECESSION MS will be increased. Money Market. QID1. - PowerPoint PPT Presentation

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  • Janet Yellen1%?2%?1.5%?The FedMonetary Policy

  • Real GDPPLSRASAD2YRYF [Incr G; Decr T] PL1AD1PL2GADY/Empl./PL;GLFMI.R.TDICADY/Emp/PL;TLFMIRStart from a Balanced BudgetG & T = $2 Trillion$2 TI cant get a job.Now, this is better. G TE1E2LRASD1D2SLoanable Funds Market r=6%r=8%Real In. RateF1F2$2 T$2.2 T

  • Real GDPPLSRASAD2YIYF[Decr G; Incr T ]PL1AD1PL2GADY/Empl./PL;GLFMI.R.TDICADY/Emp/PL;TLFMIRStart from a Balanced BudgetG & T = $2 Trillion$2 tril.. G T[like we have money trees]E1E2LRASLoanable Funds Market Real In. Rater=3%r=6%D1D2F1F2S$2 T tril.$2.2 T tril.$1.8 tril..

  • YR

    DMInvestmentDemandnominal Interest Rate 8

    4

    0Money MarketQID1 MS1ASAD1PL1 8%

    6%

    4%

    0MS2AD2PL2Price levelIf there is a RECESSIONMS will beincreased.QID2DIY*Buy BondsMSI.R.QIDADY/Emp/PLI want a job as a Rockette Real GDPBuy

    E1E26%

  • DIAD1Price level YIDmInvestmentDemandNominal Interest Rate10%

    8%

    6%

    0Money Market QID2 AS10

    8

    6

    0AD2PL2MS1PL1MS2If there isINFLATION,MS will bedecreased.Sell

    QID1Y*Its cheaper to burn moneythan wood. SellBondsMSI.R.QIDADY/Empl./PLlikemoney treesE1E2

  • 0Real GDPAD1AD2AS1AS2PL1PL2PL3Y*1Y2Y3Can sustain a much greater increase in AD if the AS curve isalso shifting to the right, due to increasing productivity.Economys Speed Limit at Full Employment is 4%, instead of 2.5%.2.5%In the early 90s, at FE, 2.5%was the speed limit. AS shiftedslowly due to low productivity.So, at FE, the goldilockseconomy has expanded.PL1Increasing productivity of thelate 90s allowed more growthat full employment.

  • Recent GDP

  • The Fed is Like a Student Driver

  • If The Economy Is Exceeding The FE GDP Speed Limit Of 4%

  • Beating the Inflation Dragon

  • When the party gets too good, its the job of the Fed to take away the punch bowl. The Feds policy is If you see inflation, its too late. Whip it before it gets out of the box.

    During a recession, the Fed is happy to spike the punch. I promise to control inflation

  • Should The Fed Chairman Show His Hand?

  • For Richer or For Poorer For Andrea, it took 12 years to get a marriage proposal she could understand. [She got 3, but didnt understand what he was saying]

  • Greenspan Sworn in for another 4-year Term

  • Each Night Andrea Has To Check Under The Bed & In The Closet For Signs Of Inflation Andrea, get that inflation out of the closet.Greenspan seems to speak in tongues, called Fed-speak.

  • Last Paragraph of Mr. Greenspans Marriage Proposal Despite these concerns, and in the final analysis, the more preponderous weight of evidence considered in these deliberations falls on the side of a matrimonial rapproachement. I am prepared to act on these conclusions where warranted, with your consent, in a way that is consistent with my role as chairman of the Federal Reserve.This was Fedspeak for, Will You Marry Me?

  • Monetary Policy Americas Main Stabilization ToolMonetary Policy ToolsDiscount Rate when banks borrow from the Fed [symbolic]Reserve Ratio currently 10%; the most powerful toolBuying [recession] & selling [inflation] of bondsRecessionInflationNominalInterestRate

  • BALANCE SHEET OF FED BANKSASSETSSecurities [90%]Loans to Commercial BanksLIABILITIESReserves of Commercial BanksTreasury DepositsFederal Reserve Notes [90%]

  • AustraliaReserve Bank of Australia [RBA]Canada Bank of CanadaEuro Zone Central Bank of Europe[CBE]Japan The Bank of Japan [BOJ]Russia Central Bank of RussiaUnited KingdomBank of EnglandMexico Banco de Mexico (Mex Bank)Sweden Sveriges RibsbankU.S. Federal Reserve System [Fed]Consolidated Balance Sheet of the Federal Reserve Banks[millions]

    Assets[own] Liabilities[owe]Securities*647,580 Reserves of commercial banks $28,678 Treasury deposits 6,050Loans to Commercial Banks 59 Federal Reserve Notes *549,711 [when these notes are in circulation, they constitute claims against assets of the Fed]All other assets 86,768 All other liabilities & net worth 49,723Total$734,407 Total $734,407

  • $97.50+30%The Fed controls the banks ability to create new money to ensure the economy doesnt get too much money, nor too little.OverfedFed Right19801983$75.00MoneyPricesUnderfed

  • And What Happens If You Feed A Dog too Much

  • 1. Discount Rate banks borrow from the Fed (symbolic)2. Required Reserve - % of DD which cannot be loaned.3. Buy/Sell Bonds government debt

    - 3 mo., 6 mo., & 1 year; purchase price: $10,000

    - 2 yr., 3 yr., 5 yr.,($5,000), & 10 yr., ($10,000)

    - 30 years with purchase of $1,000

    Federal Funds Target Rate overnight lending rate between banks to correct a temporary imbalance in reserves.RecessionLowerLowerBuyInflationRaiseRaiseSellYR Y*ADASLRASASADY*YI3 Tools of Monetary PolicyJune, 2006 [5.25%]17 increasesADADReal GDP 1.6%Prime Rate-loan rate to the best (prime) customers.

  • YR Real GDPDMInvestmentDemandNominal Interest Rate10

    8

    6

    0Money MarketQID1 Easy Money During RecessionsMS1ASAD1P110

    8

    6

    0MS2P2Price levelBuy

    If there is RECESSIONMS will beincreased.QID2DIY*Easy Money (Buy/Sell) bonds,which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate)the dollar, which (increase/decrease)C, Ig, & Xn, which (increase/decrease)AD & therefore, PL, GDP, & emp. E1E2AD2Jobs are tough to get.LRASStudents, should the Fed buy or sell bonds to jumpstart this economy?

  • DIAD1 YIDmInvestmentDemandNominal Interest Rate10

    8

    6

    0Money MarketQID2 AS10

    8

    6

    0P2MS1P1MS2If there isINFLATION,MS will bedecreased.Sell

    QID1Y*Tight Money during InflationTight Money (Buy/Sell)bonds, which (incr/decr) the MS,which (incr/decr) in. rates, which (apprec/deprec) the dollar,which (incr/decr) C, Ig, & Xn,which (incr/decr) AD, PL,& GDP.E1E2AD2Now, should I buy or sell?Ill get rid of some money.LRAS

  • YR Y* Investment Demand9%

    6%

    3%

    0Money Market $50 $60ASAD1PL19%

    6%

    3%

    0MS2AD2PL2$70YIAD3DIDmPL3MS1MS3 $100 120 140QIDI=$50]I=$60I=$70RDOThe ideal economy is AD2, with I.R. at 6% & Ig at $60 billion.

  • YR Investment Demand9%

    0Money Market $50 ASAD1PL19%

    0MS2AD2PL2DIDmMS1 $100 QIDI=$50]I=$60RDORecessionary GapIncrease MS from $100 to $120, which lowers the I.R. from 9% to 6%, which increases QID from $50 to $60, which increases AD from AD1 to AD2.

    6%6%$120 $60Y*

  • Y* Investment Demand

    3%

    0Money Market $60AS

    3%

    0MS2AD2PL2$70YIAD3DIDmPL3MS3$140QIDI=$60I=$70RDOInflationary GapDecrease MS from $140 to $120, which increases the I.R. from 3% to 6%. which decreases QID from $70 to $60, which decreases AD from AD3 to AD2.6%6%$120 DI

  • GOALS OF MONETARY POLICY to assist the economy in achieving a full employment, non-inflationary level of output

  • 1. Open Market Operations

    - nuts and bolts of Monetary Policy [main tool]

    - $60-$70 billion every dayThree Tools Of Monetary Policy

  • 2. Reserve Requirement - most powerful (seldom used) - affects money creation by changing ER and the multiplier - an increase of of 1% would increase bank reserves by over $5 billion - RR was 20% from 1937-1958 Sledgehammer of Monetary PolicyRR - Atomic Bomb of Monetary Policy

  • Reserve Requirement ExampleSuppose the banking system has $500 billion in DD.The RR is 12% & TR are $60 billion, which is 12% of the $500 billion DD. So, there are no ER.

    Now, the Fed lowers the RR to 10%. Now banks arerequired to keep only $50 billion in RR. So, $10 billion more ER is available to loan out.$10 billion X 10 = $100 billion in new DD.So, 20% increase MS [DD] from $500 to $600 billion.Atomic Bomb of Monetary Policy

  • $10,000[$9,000+$1,000]

    [In 1980, the RR was set at 12%; stayed there until 1992; went to 10%]Easy MoneyASAD1AD2YR Y* PL$1,000Initialdeposit$900[$900x10]

    $1,000

    $810

    $729

    Monetary Expansion[10% RR] [1/.10=10]Easy MoneyReserve Requirement at 10% - Easy MoneyEasy Money increase the money supply

  • $5,000[$4,000+$1,000]

    Tight Money - decrease the money suplyRR at 20% - Tight MoneyMonetary Expansion(20% RR) [1/.20=MD of 5]Tight Money$1,000Initial deposit$800

    $640

    $512

    PL Y* YIAD2AD1AS

  • 3. Discount Rate - emergency Fed loans to banks- symbolic (raises Prime Rate)- Discount Rate was 1% from 1934-46 and the prime rate was 1.5%HurricaneEarthQuakeFL borrowed $99million In 1991 The Fed tends to change the D.R. inlockstep with the fed funds target rate.

  • Part of Uncle Sams Menu [$1,000,000 T-bond]

  • Monetary Policy At WorkDuring this period, 1990-1992, the Fed did 4 things:1. Decreased discount rate from 10% to 3%; 2. Decreased the RR from 12% to 10%; 3. Decreased the Fed Funds Rate 24 times, and 4. Bought bonds

  • Fed Funds Rate 1