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Monetary Policy Goals, Strategy, Tactics Week 10 (Chap 16)
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Three Tools of Monetary Policy Open market operations Discount rate Reserve requirements
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Open Market Operations 2 Types 1.Dynamic: Meant to change MB 2.Defensive: Meant to offset other factors affecting MB, typically uses repos Advantages of Open Market Operations 1.Fed has complete control 2.Flexible and precise 3.Easily reversed 4.Implemented quickly
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Discount Rate as Ceiling on Fed Funds Rate Rightward shift of R s to R s 2 moves equilibrium to point 2 where i 2 ff = i d and discount lending rises from zero to DL 2
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Discount Rate Advantages 1.Lender of Last Resort Role Disadvantages 1.Confusion interpreting discount rate changes 2.Fluctuations in discount loans cause unintended fluctuations in money supply 3.Not fully controlled by Fed
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Reserve Requirements Advantages 1.Powerful effect Disadvantages 1.Small changes have very large effect on M s 2.Raising causes liquidity problems for banks 3.Frequent changes cause uncertainty for banks 4.Tax on banks
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Quantity Equation MV=PQ
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Money Growth and Inflation
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Goals of Monetary Policy Goals 1.Price Stability 2.Economic Growth 3.High Employment 4.Interest Rate Stability 5.Financial Market Stability 6.Foreign Exchange Market Stability Goals often in conflict
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Time Inconsistency Problem Rules versus discretion Solution: Fixed Rules
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Hierarchical Mandate “The primary objective of the European System of Central Banks [ESCB] shall be to maintain price stability. Without prejudice to the objective price stability, the ESCB shall support the general economic policies in the Community.”
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Dual Mandate “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
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Money Supply Target 1. M d fluctuates between M d' and M d'' 2. With M-target at M*, i fluctuates between i' and i''
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Interest Rate Target 1.M d fluctuates between M d' and M d'' 2.To set i-target at i* M s fluctuates between M' and M''
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Criteria for Choosing Targets 1.Measurability 2.Controllability 3.Ability to predictably affect goals Interest rates aren’t clearly better than M s on criteria 1 and 2 because hard to measure and control real interest rates
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