ch11notes - Central Bank Policy Central Banks influence...

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Unformatted text preview: Central Bank Policy Central Banks influence credit markets and the money supply Open Market Operations (OMOs) Open market purchases and sales of government securities Purchases: exchange money for bonds Sales: exchange money for bonds OMOs may be used to control the money supply. OMOs may also be used to influence interest rates. Interest rate: rate of return on a bond Bond of Price Bond of Price- Value Maturity return of Rate = = t i 1 Bond of Price Value Maturity - = t i An OM purchase increases bond price lower interest rate An OM sale decreases bond price higher interest rate U.S. Central Bank: the Federal Reserve System the FED Current FED policy focuses on interest rates, not the money supply Specific FED target is the Federal Funds rate Interest rate at which banks borrow from one another Distinction between FF rate and bond rate is a minor detail We can return to this later Note that t i is the nominal interest rate The interest rate in the IS curve is the real interest rate, t R Recall that - = t t i R Short-run model takes inflation as given Inflation does not immediately respond to monetary policy We provisionally assume that FED policy sets t R Short-run Equilibrium: IS and MP Real Interest Rate, Short-run Output, IS MP Policy Choices An increase in t R initiated by the FED shifts MP upward. An upward shift in MP decreases t Y ~ A decrease in t R initiated by the FED shifts MP downward. A downward shift in MP increases t Y ~ The FED may act to try to keep ~ = = t t t Y Y Y Suppose that we start with r R t = and ~ = t Y Now suppose that there is a disturbance that shifts IS to the left Perhaps there is a loss in consumer confidence and c a decreases Suppose that the size of the shift in IS is -2% Initial Position of the Economy Real Interest Rate, r IS 1 MP 1 Short-run Output, Effect of the Shock with no Policy Response Real Interest Rate, r IS 1 MP 1-2% IS Short-run Output, Now suppose that the FED wanted to keep...
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This note was uploaded on 07/17/2008 for the course ECON 502.02 taught by Professor Mccafferty during the Spring '08 term at Ohio State.

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ch11notes - Central Bank Policy Central Banks influence...

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