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Chapter 16_Monetary Policy - MONETARY POLICY CHAPTER 1 6...

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MONETARY POLICY 16 CHAPTER
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Objectives After studying this chapter, you will be able to Distinguish among the instruments, ultimate goals, and intermediate targets of monetary policy and review the Fed’s performance Describe and compare the performance of a monetarist fixed rule and Keynesian feedback rules for monetary policy Explain why the outcome of monetary policy crucially depends on the Fed’s credibility Describe and compare the new monetarist and new Keynesian feedback rules for monetary policy
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What Can Monetary Policy Do? In 2001, real GDP shrank and unemployment increased. Alan Greenspan cut the interest rate to stimulate production and jobs. Were these actions the right ones? Can and should monetary policy try to counter recessions? Or should monetary policy focus on price stability?
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Instruments, Goals, Targets, and the Fed’s Performance To discuss monetary policy if we distinguish among: Instruments Goals Intermediate targets
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Instruments, Goals, Targets, and the Fed’s Performance The instruments of monetary policy are Open market operations The discount rate Required reserve ratios The goals of monetary policy are the Fed’s ultimate objectives and are Price level stability Sustainable real GDP growth close to potential GDP
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Instruments, Goals, Targets, and the Fed’s Performance The Fed’s instruments work with an uncertain, long, and variable time lag. To assess its actions, the Fed watches intermediate targets. The possible intermediate targets are Monetary aggregates (M1 and M2, the monetary base) The federal funds rate The Fed’s intermediate target is the federal funds rate.
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Instruments, Goals, Targets, and the Fed’s Performance Price Level Stability Unexpected swings in the inflation rate bring costs for borrowers and lenders and employers and workers. What Is Price Level Stability? Alan Greenspan defined price level stability as a condition in which the inflation rate does not feature in people’s economic calculations. An inflation rate between 0 and 3 percent a year is generally seen as being consistent with price level stability.
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Instruments, Goals, Targets, and the Fed’s Performance Sustainable Real GDP Growth Natural resources and the willingness to save and invest in new capital and new technologies limit sustainable growth. Monetary policy can contribute to potential GDP growth by creating a climate that favors high saving and investment rates. Monetary policy can help to limit fluctuations around potential GDP.
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Instruments, Goals, Targets, and the Fed’s Performance The Fed’s Performance: 1973–2003 The Fed’s performance depends on Shocks to the price level Monetary policy actions
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Instruments, Goals, Targets, and the Fed’s Performance Shocks to the price level during the 1970s and 1980s made the Fed’s job harder World oil price hikes Large and increasing budget deficits Productivity slowdown These shocks intensified inflation and slowed real GDP growth.
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Instruments, Goals, Targets, and the
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