Chapter Twelve: The Federal Reserve and Monetary Policy.

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Presentation transcript:

Chapter Twelve: The Federal Reserve and Monetary Policy

Monetary Policy

Table 12.1: A Simplified Balance Sheet of the Federal Reserve

Table 12.2: An Open Market Purchase of Government Bonds by the Fed

Table 12.3: A Loan by ABC Bank Becomes a Deposit in XYZ Bank

The Theory of Money, Interest Rates, and Aggregate Demand

Quantity of Federal Funds Borrowed and Lent Federal Funds Rate 6 % Supply of Federal Funds Demand for Federal Funds E Figure 12.1a: The Market for Federal Funds

Federal Funds Rate 6 % New Supply of Federal Funds Demand for Federal Funds E1E1 E0E0 5 % Original Supply of Federal Funds Quantity of Federal Funds Borrowed and Lent Figure 12.1b: An Open Market Purchase Lower the Federal Funds Rate

Quantity of federal funds borrowed and lent Federal Funds Rate Demand for Federal Funds E1E1 A E0E0 5 % Supply of Federal Funds Target Rate B Figure 12.2: Maintaining the Federal Funds Target Rate

Prime Rate Fed Funds Rate Figure 12.3: The Federal Fund and Prime Rates Source: Federal Reserve Board, monthly data

Intended Investment (I I ) Interest rate (r ) I r0r0 I I0 I I1 r1r1 Figure 12.4: The Intended Investment Schedule

Intended Investment (I I ) Interest rate (r ) I I*I** r II’II’ Figure 12.5: An Increase in Investor Confidence

Expansionary monetary policy Lowers interest rates Investment is encouraged Aggregate demand rises Equilibrium GDP rises

45 Income Aggregate Demand and Output AD 1 (with new, lower interest rate, r 1 ) E1E1 E0E0 AD 0 (with old interest rate, r 0 ) Y1Y1 Y0Y0 Figure 12.6: Expansionary Monetary Policy and the AD Curve

Monetary Policies in Practice

Federal Funds Rate (%) Figure 12.7a: Monetary Policy and Investment,

Private Fixed Investment (billions of 2005 chained dollars) Nonresidential Investment Figure 12.7b: Monetary Policy and Investment,

Intended Investment (I I ) Interest rate (r ) I*I** 5% A II’II’ 8% Original Target Rate New Target Rate I B Figure 12.8: Expansionary Monetary Policy in an Environment of Pessimism

Appendices

Quantity of Bonds Price of Bonds (and interest rate) $ 100 (i = 5%) Supply of Bonds Demand for Bonds E Figure 12.9a: The Market for Government Bonds

Quantity of Bonds Price of Bonds (and interest rate) $ 100 (i = 5%) Supply of Bonds Original Demand for Bonds E0E0 E1E1 $103 (i = 2%) New Demand for Bonds Figure 12.9b: The Market for Government Bonds

Interest Rate (%) Figure 12.10: The Federal Funds and Three-Month Treasury Bill Rates,

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