Finance 301 1st Edition Lecture 7 Outline of Last Lecture I Organizational structure of the Fed II How Fed Controls Money Supply III How Fed operations effect interest rates IV Adjusting Reserve Requirement Ratio V Adjusting the Fed s Loan Rate VI Feds Lending Role During Credit Crisis Outline of Current Lecture VII Mechanics of Monetary Policy VIII Limitations of Monetary Policy IX Tradeoff in Monetary Policy X Monetary Policy Shifts Overtime due to Trade Offs Current Lecture I Mechanics of Monetary Policy a GDP gross domestic profit all goods and services produced in the united states can calculate monthly its going up economic activity is better b National income publish this salaries going up economy going up c Unemployment rate shows weather or not companies are willing to grow hire or fire people just cause it is going down does not mean the economy is growing d Industrial production how much we are creating and foundation for business in this country Dow Jones used to track stocks and transportation stocks cause they should lead our economy e Retail sales index shows that people are buying thing good for FED and economy f Home sales index almost everything in economy focused construction home stores mortgages financial crisis g i 2 Whose getting unemployment leads out economy ii 4 Delivers to a retail or manufacture slow we have to buy a lot more goods to deliver shows economy is good iii 6 People have money to buy new houses iv 7 S P 500 stock crisis is indicator because shows consumer confidence buying and selling anticipated expectations v Stocks tell us if they start going up vi Expectations lead the economy vii Coincident happen at the same time viii Less employees economy is doing bad ix 3 Producing now economy running x 4 Manufactors happening now xi Lagging xii How long unemployment will last lag economy because xiii Inventories good economy have little inventory bad economy lot of inventory xiv 7 Measures inflation xv 5 Loan money to businesses this is a good thing economy is improving not making loans its bad cause no one is borrowing h Limit inflation to 1 to 2 i Wage rates wages going up prices of good have already gone up j Oil Prices prices of goods and services are going up because it costs more to transport goods its used by industries to produce as well we drive everywhere traveling k Economic growth growing prices gonna go up l Gold Prices m Producer and consumer price indexes Producer price index represents prices at the wholesale level and the consumer price index represents prices paid by consumers retail level n Once the Federal Open Market Committee assesses economic conditions it can identify its main concerns about the economy and determine the proper monetary policy that would alleviate its concerns i Monetary policy moves 1 Buy and sell treasuries 2 Change discount rate 3 Change reserve requirement o The supply curve of loanable funds indicates the quantity of funds that would be supplied at that time at various possible interest rates p Fed is going to lower interest rates buy treasuries put money out there q Make interest rates higher sell treasuries raise interest rates r s t II Limitations of Monetary Policy a Impact of a Credit Crunch even if the Fed increases the level of bank funds banks may be unwilling to extend credit b Impact of a Stimulative Policy on Expected Inflation effect of increase in money supply growth may be disrupted due to an increase in inflationary expectations c Lagged Effects of Monetary Policy d Recognition lag realizing there s a problem like high unemployment or inflation e Implementation lag putting policies in place the time it takes f Impact lag how long it takes policy to have an effect on the market III Tradeoff in Monetary Policy a Ideally the Fed would like to achieve both a very low level of unemployment and a very low level of inflation in the United States b Inverse relationship between inflation and unemployment c Strong economic conditions high inflation low unemployment d Weak economic conditions high unemployment low inflation cant raise prices because no one is buying goods e Impact of other forces on the tradeoff i Have to make a decision historical data has shown that they fight for unemployment first by lowering interest rates federal funds rate and discount rate ii Hard to balance both of them at the same time because they go in opposite directions IV Monetary Policy Shifts Overtime due to Trade Offs a Shifts in Monetary Policy over Time i Focus on improving a weak economy in 2001 2003 ii Focus on reducing inflation in 2004 2007 iii Focus on improving weak economy in 2008 2009 b How Monetary Policy Responds to Fiscal Policy i Fiscal policy government spending can create large budget deficits ii 1 Because if they borrow a lot of money effect wheres other borrowers can borrow money iii 2 Try to lower interest rates put more money out in the money supply print more money if we like it or not quit running deficits iv 3 Fiscal policy effects the demand for funds and monetary policy affects supply of funds put more money out on market take out if needed v