Finance 301 1st Edition Lecture 7Outline of Last Lecture I. Organizational structure of the FedII. How Fed Controls Money SupplyIII. How Fed operations effect interest ratesIV. Adjusting Reserve Requirement RatioV. Adjusting the Fed’s Loan RateVI. Feds Lending Role During Credit CrisisOutline of Current LectureVII. Mechanics of Monetary PolicyVIII. Limitations of Monetary PolicyIX. Tradeoff in Monetary PolicyX. Monetary Policy Shifts Overtime due to Trade OffsCurrent LectureI. Mechanics of Monetary Policya. GDP- gross domestic profit, all goods and services produced in the united states can calculate monthly, its going up , economic activity is betterb. 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 growingd. 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 economye. Retail sales index- shows that people are buying thing, good for FED and economyf. Home sales index- almost everything in economy focused, construction, home stores, mortgages, financial crisis g.i. 2. Whose getting unemployment, leads out economyii. 4. Delivers to a retail or manufacture, slow we have to buy a lot more goods to deliver, shows economy is goodiii. 6. People have money to buy new housesiv. 7. S&P 500 stock crisis is indicator because shows consumer confidence, buying and selling anticipated expectationsv. Stocks tell us if they start going upvi. Expectations- lead the economyvii. Coincident- happen at the same timeviii. Less employees, economy is doing badix. 3. Producing now economy runningx. 4. Manufactors happening now, xi. Laggingxii. How long unemployment will last, lag economy because xiii. Inventories- good economy have little inventory bad economy lot of inventoryxiv. 7. Measures inflationxv. 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 upj. Oil Prices- prices of goods and services are going up because it costs moreto transport goods its used by industries to produce as well, we drive everywhere, travelingk. Economic growth- growing, prices gonna go upl. 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 moves1. Buy and sell treasuries2. Change discount rate3. Change reserve requiremento. 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 thereq. Make interest rates higher sell treasuries raise interest ratesr.s.t.II. Limitations of Monetary Policya. 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 inflatione. Implementation lag – putting policies in place, the time it takesf. Impact lag – how long it takes policy to have an effect on the marketIII. Tradeoff in Monetary Policya. 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 unemploymentd. Weak economic conditions: high unemployment, low inflation cant raiseprices because no one is buying goodse. Impact of other forces on the tradeoffi. Have to make a decision historical data has shown that they fight for unemployment first by lowering interest rates, federal funds rate and discount rateii. Hard to balance both of them at the same time because they go inopposite directions IV. Monetary Policy Shifts Overtime due to Trade Offsa. Shifts in Monetary Policy over Timei. Focus on improving a weak economy in 2001-2003ii. Focus on reducing inflation in 2004-2007iii. Focus on improving weak economy in 2008-2009b. How Monetary Policy Responds to Fiscal Policyi. Fiscal policy- government spending, can create large budget deficitsii. 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 deficitsiv. 3. Fiscal policy effects the demand for funds and monetary policy affects supply of funds put more money out on market/ take out