17%20Monetary%20Policy,%20Part%202

17%20Monetary%20Policy,%20Part%202 - Agenda Monetary Policy...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
1 17-1 Monetary Policy and the Federal Reserve System, Part 2 17-2 Agenda • Monetary Policy Control ¾ Intermediate targets ¾ Making monetary policy in practice • Rules versus Discretion 17-3 Monetary Policy Control • Intermediate targets: ¾ The Fed uses intermediate targets to guide policy as a step between its tools and its goals or ultimate targets of price stability and stable economic growth. 17-4 Monetary Policy Control • Intermediate targets: ¾ Intermediate targets are variables the Fed cannot directly control but can influence predictably and are related to the Fed’s goals. ¾ Examples include: • The monetary aggregates such as M1 and M2, and • Short-term interest rates, such as the Fed funds rate
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 17-5 Monetary Policy Control • Intermediate targets: ¾ The Fed cannot target both the money supply and the Fed funds rate simultaneously. • Suppose both the money supply and the Fed funds rate were above target, so the Fed needs to lower them. • Since a decrease in the money supply shifts the LM curve up, it will increase the Fed funds rate. ¾ In recent years, the Fed has been targeting the Fed funds rate. 17-6 Monetary Policy Control • Intermediate targets: ¾ Interest rate targeting works well if the main shocks to the economy are to the LM curve • Shocks to money supply or money demand. ¾ This strategy stabilizes output, the real interest rate, and the price level because it completely offsets any shocks to the LM curve. 17-7 Interest rate targeting with LM shocks Y r 17-8 Monetary Policy Control • Intermediate targets: ¾ However, if the shocks come to the economy are from the IS curve, then policy may be destabilizing. • Unless the Fed changes its target Fed funds rate.
Background image of page 2
17-9 Monetary Policy Control • Intermediate targets: ¾ Suppose a shock shifts the IS curve to the right. • If the Fed were to maintain the real interest rate, it would increase the money supply, thus making output rise even more, which would be destabilizing. • Instead, the Fed needs to raise the real interest rate to stabilize output. 17-10 Interest rate targeting with IS shocks Y r 17-11 Monetary Policy Control • Intermediate targets: ¾ Suppose a shock shifts the IS curve to the right. • Research suggests that the optimal Fed funds rate varies substantially over time. – This implies that IS curve shocks overwhelm LM curve shocks. 17-12 Monetary Policy Control • Making monetary policy in practice: ¾ The IS-LM model makes monetary policy look easy—just change the money supply to move the economy to the best position possible. • Two issues make it much harder in practice: Time lags in the effect of policy, and Uncertainty about exactly the ways monetary policy effects the economy. » These are known as the monetary policy transmission channels.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 09/04/2010 for the course EEP 175 taught by Professor Christiantraeger during the Fall '09 term at Berkeley.

Page1 / 12

17%20Monetary%20Policy,%20Part%202 - Agenda Monetary Policy...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online