1. Eco 200 – Principles of Macroeconomics Chapter 14: Monetary Policy

2. Federal Reserve System Debate over central bank – First and Second National Banks Federal Reserve Act – 1913 12 District Banks Board of Governors – 7 members - 14 year “non-renewable” term Chair of Board – 4-year term – does not coincide with President’s term – “second most powerful person in the U.S.” 12 District Banks – 9 person board (6 elected by members banks in the district, 3 appointed by Board of Governors) Federal Open Market Committee – 12 members (Board of Governors + 5 District Bank Presidents selected on a rotating basis, but always including President of NY Fed)

3. Fed autonomy Autonomous? 14-year terms The President does not appoint a majority of the board in a single term in office No need for budget request from Congress Autonomy created by act of Congress and may be removed by an act of Congress.

4. Functions of the Fed Provides banking services and supervision Supplies currency Holds reserves Clears checks Makes loans to banks (discount loans) Controls the money supply

5. Implementing monetary policy Policy goals: economic growth, low unemployment, and price stability Intermediate targets – objectives that are used to help achieve policy goals (examples: money supply or interest rate targets)

6. Equation of Exchange MV = PY M = quantity of money P = price index Y = real GDP V = # of times a typical dollar is used to purchase GDP = PY / M Quantity theory of money V is constant (and Y is constant in the long run) Changes in M result in changes in proportionate changes in nominal GDP (and only in the price level in the long run)

7. Tools of monetary policy Reserve requirement Discount rate (also affects the federal funds rate) Discount rate – interest rate charged by Fed on loans of reserves to banks Federal funds rate = interest rate charged by banks on loans of reserves to other banks Open market operations – buying or selling government bonds (most commonly used tool of monetary policy)

8. Monetary policy To expand the money supply, the Fed may: Lower the reserve requirement ratio Lower the discount rate Buy government securities

9. Foreign Exchange Market intervention Buying or selling currencies to maintain target exchange rate Shown on board Sterilization – open market operations to offset the domestic money supply effect of foreign exchange market intervention

10. Money demand Reasons for holding money: Transactions demand Precautionary demand Speculative demand Quantity of money demanded: Rises as nominal income rises (a higher price level or higher real GDP results in an increase in demand) Declines as the interest rate rises

11. Money demand

12. Money demand and income

13. Money Supply

14. Equilibrium

15. Monetary transmission mechanism: Keynesian model

16. Monetary transmission mechanism (cont.)