Chapter 14 notes

Chapter 14 notes - Chapter 14 Notes Monetary Policy What is...

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Chapter 14 Notes Monetary Policy What is Monetary Policy? Monetary Policy : the actions the Federal Reserve takes to manage the money supply and interest rates to pursue its economic objectives. The Goals of Monetary Policy Four goals intended to promote a well-functioning economy: o Price Stability o High employment o Economic Growth o Stability of financial markets and institutions Most important goals: price stability and high employment. Price Stability If inflation is low over the long run, the Fed will have the flexibility it needs to lessen the impact of recessions. High Employment Unemployed workers and underused factories and office buildings reduce GDP below its potential level. Unemployment causes financial distress and decreases self-esteem for workers who lack jobs. The Employment Act of 1946 states that the Fed is to promote employment. Economic Growth Stable growth allows households and firms to plan accurately and encourages the long- run investment that is needed to sustain growth. Stability of Financial Markets and Institutions This is promoted so that an efficient flow of funds from savers to borrowers will occur. When the financial markets are not efficient in matching borrowers and savers, resources are lost. Savers waste resources looking for investments and firms cannot obtain financing. The Money Market and the Fed’s Choice of Targets A policy that is intended to achieve one monetary policy goal, such as lower inflation, may have an adverse effect on another policy goal, such as economic growth. So main goal of price stability has been established Monetary Policy Targets Since the Fed cannot tell companies how many people to employ or what prices to charge, they use variables called monetary policy targets . These variables such as real GDP and the price level, are closely related to the policy goals. Two main policy targets: money supply and the interest rate. The Demand for Money Graph: inflation is on vertical and quantity of money is on horizontal. The demand curve for money is downward sloping. When interest rates rise on financial assets such as US Treasury Bills, the amount of interest that households and firms lost by holding money increases.
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The interest rate is the opportunity cost of holding money. When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is low, so the quantity of money demanded by households and firms will be high. Shifts in the Money Demand Curve Changes in variables other than interest rate cause the demand curve to shift. The two most important variables that cause the money demand curve to shift are real GDP and the price level. An increase in real GDP means that the amount of buying and selling of goods/services
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This note was uploaded on 10/22/2007 for the course ECON 205 taught by Professor Kamrany during the Fall '07 term at USC.

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Chapter 14 notes - Chapter 14 Notes Monetary Policy What is...

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