UB ECO 182 - Chapter 12 Monetary Policy (11 pages)

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Chapter 12 Monetary Policy Monetary Policy Before and After the Crisis FFR History The 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 09 Three Key points of Monetary Policy during Financial crisis I FFR Target current rate is 0 25 and has been this way since 01 09 II Lender of last resort III Quantitatiive Easing Quantitative 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 rate As r falls the of holding money falls so people hold money An increase in or would shift MD to the right while a fall in or would shift the curve to the left Equilibrium in the Money Market The Supply of money is determined by The primary way that the Fed can change the money supply is through 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 the interest 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 Economy The net