Monetary PolicyBackground InformationMain GoalsGoals of Monetary PolicySlide 5Slide 6Slide 7Slide 8Slide 9Tools used to implement Monetary PolicyReserve RequirementsSlide 12Discount WindowSlide 14Open Market OperationsOpen Market TransactionsSlide 17Limitations of Monetary PolicySlide 19ConclusionMonetaryMonetary PolicyPolicyBy Teresa StearnsBy Teresa StearnsBackground InformationBackground InformationWhat is monetary policy?What is monetary policy?Who conducts monetary policy?Who conducts monetary policy?•FOMCFOMCMain GoalsMain GoalsPrice stabilityPrice stabilityHigh employmentHigh employmentEconomic growthEconomic growthStabilize foreign exchange ratesStabilize foreign exchange ratesGoals of Monetary PolicyGoals of Monetary PolicyProvide price stabilityProvide price stability•Inflation-creates chain reactionInflation-creates chain reactionSupplier passes on to customer (Monaco Supplier passes on to customer (Monaco Coach)Coach)•What does Fed do to counteract What does Fed do to counteract inflation?inflation?Increase interest ratesIncrease interest rates•Goal of zero inflation?Goal of zero inflation?Goals of Monetary PolicyGoals of Monetary PolicySlow growth of money and credit People and businesses cannot make major purchasesUnemployment and/or recessionRapid growth of money and creditEconomy cannot produce goods and services fast enoughInflationGoals of Monetary PolicyGoals of Monetary PolicyCreate high employmentCreate high employment•Is it reasonable to want full Is it reasonable to want full employment?employment?No, because of frictional unemploymentNo, because of frictional unemployment•What happens when the unemployment What happens when the unemployment rate gets to high?rate gets to high?Stimulate economy by increasing money Stimulate economy by increasing money supplysupplyDecrease interest rateDecrease interest rateGoals of Monetary PolicyGoals of Monetary PolicyCreate economic growthCreate economic growth•Need to increase the output of goods Need to increase the output of goods and servicesand services•Needs to be steady and sustainableNeeds to be steady and sustainable•Provide high employmentProvide high employment•How can we stabilize the economy in the How can we stabilize the economy in the short-run?short-run?Decrease interest ratesDecrease interest ratesGoals of Monetary PolicyGoals of Monetary PolicyStability in foreign exchange ratesStability in foreign exchange rates•What happens when Fed increases What happens when Fed increases interest rates?interest rates?Value of dollar risesValue of dollar rises•Strong dollar vs Weak dollarStrong dollar vs Weak dollar•Who benefits?Who benefits?Goals of Monetary PolicyGoals of Monetary PolicyValue of dollar Impact on imports/exports FallsRisesCost of imports riseCost of exports fallCost of imports fallCost of exports risesIncreases U.S. inflationBoosts U.S. output Decreases U.S. inflationReduces U.S. outputTools used to implement Tools used to implement Monetary PolicyMonetary PolicyReserve requirementsReserve requirementsDiscount windowDiscount windowOpen market operationsOpen market operationsReserve RequirementsReserve RequirementsPurpose?Purpose?Two componentsTwo components•Required reservesRequired reservesVault cashVault cashReserve balancesReserve balancesAmounts are determined by required reserve Amounts are determined by required reserve ratioratio•Excess reservesExcess reservesCan borrow from other banks in federal Can borrow from other banks in federal funds marketfunds marketReserve RequirementsReserve RequirementsIncrease in required reserves Increase in required reserves •Reduces bank lendingReduces bank lending•Decreases spending for consumersDecreases spending for consumers•Businesses can’t expandBusinesses can’t expandDecrease in required reservesDecrease in required reserves•Increases lending by banksIncreases lending by banks•More spendingMore spending•Increases employmentIncreases employmentDiscount WindowDiscount WindowWhat is the discount window used What is the discount window used for?for?•Banks can borrow from Fed when they Banks can borrow from Fed when they can’t meet their required reserve can’t meet their required reserve amountsamounts•Borrow at discount rateBorrow at discount rateSet above federal funds rateSet above federal funds rate•Used as a last resortUsed as a last resortDiscount WindowDiscount WindowStrict guidelines when borrowingStrict guidelines when borrowingMany fear using discount windowMany fear using discount window•Produces bad imageProduces bad imageIncrease discount rateIncrease discount rate•Slows economySlows economyDecrease discount rateDecrease discount rate•Stimulates economyStimulates economyOpen Market OperationsOpen Market OperationsWhen the Fed buys and sells When the Fed buys and sells government securitiesgovernment securities•Transactions take place through Trading Transactions take place through Trading Desk at NY Federal ReserveDesk at NY Federal Reserve•Huge dollar transactionsHuge dollar transactionsImpact of buying and selling……Impact of buying and selling……Open Market TransactionsOpen Market TransactionsWhen the Fed Eases When the Fed TightensFed buys government securities from a firm that deals in them. Fed sells government securities to a firm that deals in them. It pays by crediting the account that the dealer’s bank has at the Fed. It pays by debiting the account that the dealer’s bank has at the Fed. The bank in turn credits the dealer’s account. The bank in turn debits the dealer’s account. The banking system has more funds to lend. The banking system has fewer funds to lend. Downward pressure on the federal funds rate—i.e. the interest rate banks charge each other for overnight loans. Upward pressure on the federal funds rate.Influences the other interest rates in the economy—which also go down. Other interest rates in the economy also rise as a result. Gives the economy a boost. Slows the economy and curbs inflation.Limitations of Monetary PolicyLimitations of Monetary PolicyDoes not have direct control over its Does not have direct control over its outcomesoutcomes•Primary use of interest ratesPrimary use of interest ratesLack up to the minute, reliable infoLack up to the