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UB ECO 182 - Chapter 12 Monetary Policy

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Chapter 12 – Monetary PolicyMonetary Policy – Before and After the Crisis FFR - HistoryThe Fed usually influences AD by setting a target for interest rates.. The interest rate that they influence is called the FFR – Federal Funds Rate.. Although, it’s actually the rate that _____________ charge ___________.. Some people blamed the low interest rates on the housing bubble that caused the recession of 08/09Three Key points of Monetary Policy during Financial crisis.I. FFR Target – current rate is 0-.25 and has been this way since 01/09II. Lender of last resortIII. Quantitatiive EasingQuantitative Easing – began first in Japan when their interest rates were almost zero. However, During the peak of the financial crisis in 2008, the Federal Reserve expanded its balance sheet dramatically by adding new assets and new liabilities without "sterilizing" these by corresponding subtractions. QE, QE2, QE3, QE infininity?...Since short-term interest rates were already _________, Fed began targeting______________ and indirectly influenceing___________________.In the long- run the interest rate is determined in the market for ________.In the short-run the interest rate is determined in the market for __________.Money Market $$$ Money demand reflects how much wealth people want to hold in ________ form.  For simplicity, suppose household wealth includes only two assets: Money – liquid but pays _________. Bonds – pay interest but not _________.People hold money for three reasons..1. Transactions Demand: The amount of money people hold to ___________________. The main determinant of Transactions demand is _______________.2. Precautionary demand: The amount of money people hold to make ___________________.3. Asset Demand- The amount of money that people hold to serve as a ________________.The main determinant of both precautionary demand and asset demand is _______________. The money demand curve shows the relationship between the quantity of money demanded and the interest rateAs r falls the ______ of holding money falls so people hold______ money.An increase in ____________ or _________ would shiftMD to the right, while a fall in _________ or____________ would shift the curve to the left.Equilibrium in the Money MarketThe Supply of money is determined by __________. Theprimary way that the Fed can change the money supply isthrough __________________: the __________ and__________ of government securities.r- will adjust until __________ = _____________. Expansionary Monetary Policy – If Y<Yn the Fed wants to ________ AD. Monetary Policy works two ways..I. Indirect Effect - Change the money supply to change theinterest rate.If they want to increase AD, then they should try to _______ the interest rates. They can do this by __________ the money supply.. This can be done by __________ bonds from individuals or banks. The Fed would Pay for the bonds, and this would eventually _________ the reserves in the banking system.As a result of more reserves, the banks will make ________ loans which will _________ the MS.II. Direct Effect - Quantitative Easing – Change the MS to directly change AD. If people are holding more ______ assets, then they are more likely to __________. Thus _________ AD. This is the policy that the Fed undertook once the _______ interest rates were ________________.Monetary Policy in an Open EconomyThe net export effect of expansionary monetary policy• The Fed _Buys_ bonds, which _increases_ the MS and _lowers_ interest rates. – This will encourage borrowing and discourage saving AD increases• Lower interest rates cause $s (Capital outflows) to _increase_ the country. + capital inflows decrease• This causes the demand for $ in the financial markets to _decrease_ which cause the value of the $ to _decrease_.• This causes the costs of Exports to _decrease_ while the costs of imports is _rising_. Thus X _increase_, M _decrease_ NX _increase_ and AD _increase_.The international effect of monetary policy is the _same_ direction as the domestic affect thus _amplifies_ to effect ofmonetary policy…With fiscal policy, the international effect dampens the effect… (ie AD decreaseGovt. borrowing pushes up interest rate. Not only crowd out I but also NXTools of the Fed:1. Open Market Operations _______________.Used to affect the money supply and target the interestrate. The main rate that they target is the ______________: which is the interest rate that depository institutions pay to ________ reserves in the interbank federal funds market. The reason this is so important is because most other ___________ are _____ to the FFR.Suppose the Fed finally pushes up the target FFR to .75%.- To raise the fed funds rate, the Fed would _____________ govt. bonds. - This ____________ reserves from the bankin system, causing the supply to ___________.- Thus banks would start charging each other ______________.II. Change the _____________ relative to the _______. Discount Rate —the interest rate on loans the ______ makes to banks—to influence the amount of reserves banksborrow When banks are running low on ________ they may ________reserves from the Fed. To increase borrowing and the MS Fed should ___ the differential ,  To decrease borrowing and the MS Fed should ____ the differential. III. Change the interest rate the Fed pays on ___________.Since 10/2008, the Fed has paid interest on reserves banks keep in accounts at the Fed. (This was done to entice banks to hold money _______ so that the Fed had money to ______________.-To increase the multiplier and increase MS the Fed should _____ this rate. IV. Change the _______________.This would change the _______ and thus the ______ effect of a change in serves.To increase the MS the Fed should ____ the rrTo decrease the MS the Fed should____ the rr.Expansionary Policy Contractionary PolicyShould be done if: should be done if:YN ___ Y YN _____ YUN____ U UN _____ UInflation is ______ Inflation is ____________ Bonds ___ rr____ _____ Bonds – ____ differential or ____ rate ____ differential or ____ rateCharged on reserves Charged on reservesMS___ r ___ MS___ r ___ C and I ___ AD ____ C and I___ AD_In the short-run monetary policy can be used to _____________ fluctuations in the economy.Long-run effects of Monetary PolicyHowever in the long-run the only effect is


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UB ECO 182 - Chapter 12 Monetary Policy

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