Chapter 6 MONETARY POLICY

Goals of Monetary Policy zPrice Stability zFull Employment zEconomic Growth zStable Interest Rates zStable Foreign Exchange Rate

Trade-Offs and Conflicts Among Policies zMonetary Policy Tools yIncrease rate of growth in money supply by supplying more reserves to banking system yDecrease rate of growth in money supply by supplying fewer reserves to banking system zConflicts between monetary policies and monetary goals

Monetary Goals and Targets zMonetary Goals zOperating Targets ymonetary and financial variables zIntermediate Targets yinterest rates and monetary aggregates

Characteristics of Targets zLinkage zObservability zResponsiveness

Choosing Operating Targets zOperating Targets yLevel of federal funds rate yLevel of borrowed and non-borrowed bank reserves yThe Fed cannot target both interest rates and reserves at the same time

Choosing Intermediate Targets zMonetary aggregates zExchange rates zLevel of national output zLevel of actual or expected inflation zInterest rates

Targeting the Fed Funds Rate: zFed’s Target: Fed funds rate yIndicator of supply of loanable funds yUse of open market operations zFed funds rate varies with economic conditions

Monetarist Experiment: zFed’s Target: Non-borrowed reserves yUse of open market operations zIntermediate Target: Monetary aggregates zOperating Target: Quantity of non- borrowed reserves zMoney Multiplier: Link between reserves and monetary aggregates

Back to the Fed Funds Rate: zOperating Target: Borrowed reserves yClosely linked to spread between fed funds rate and discount rate zUse of open market operations

Major Developments in the Mid-1980s zLevel and Stability of U.S. Dollar yPlaza Agreement in September 1985 yLouvre Accord in February 1987 zStability in Financial Markets yStock market crash in October 1987

Same Policy, But With a Twist: zFed’s Target: Short-term interest rates zUpward pressure placed on fed funds rate zLess emphasis on monetary aggregates zPrimary focus on: yprices of sensitive commodities ylevel of industrial capacity

The Last Half of the 1990s: Exploring the New Paradigm zNew Paradigm: yIncreased productivity due to new technology and accelerated capital expenditures yCapital deepening, increased labor productivity and sustainable economic growth zEclectic Approach: yNo longer focused only on absolute level of fed funds rate, monetary aggregates or commodity prices y z Main Policy Tool: Fed funds rate