Lecture 32: Monetary policy goals, strategy and tactics – part two Mishkin Ch16 – part B page 412-419

Introduction Monetary goal Monetary strategies Monetary tactics – policy instruments Monetary policy tools

Three monetary policy tools Open market operation Reserve requirements Discount policy (discount rate)

Two policy instruments Policy instruments (operating instruments): A variable that responds to the central bank’s tools and indicates the stance (loose or tight) of monetary policy Two policy instruments: Reserve aggregates: R, MBn, MB, Interest rates: short-term interest rate Interest-rate and aggregate targets are incompatible. May be linked to an intermediate target: M2, long-term interest rate, which are more closely related to goals.

Criteria for choosing the policy instrument Observability and measurability time lag in measuring reserves hard to measure real interest rate Controllability better control over nominal interest rates than over reserves Predictable effect on goals Interest rates link more closely to goals

The Taylor rule Inflation target 2%, output potential, equilibrium real fed funds rate 2% An inflation gap and an output gap Stabilizing real output is an important concern Output gap is an indicator of future inflation as shown by Phillips curve