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Policy Tools, Policy Objectives and Targets. Targets. ECO 473 - Money & Banking - Dr. D. Foster Federal Reserve Policy Tools Federal
• Open Market Operations. Buy/sell Treasury bonds to affect bank reserves. • Discount Window. Lend to member banks to affect bank reserves. • Required Reserve Ratio. Changing this affects bank excess reserves. Open Market Operations Open
• Outright transactions: A purchase/sale of securities. • Repurchase-agreement transactions: The Fed buys and the seller commits to repurchase the security at a later date. • Reverse repurchase agreements: The Fed sells and commits to repurchase the securities at a later time. • What to do if we run out of Treasury bonds? The Discount Window & Required Reserves The
• Discount Window policy: Lend against holdings of T-bonds. “Advances” made w/out collateral. Interest rate (rd) set below Fed’l Funds rate (rf) Banks will borrow from Fed creating “borrowed reserves.” Banks will borrow from each other. Interest rate (rd) set above Fed’l Funds rate (rf) • Required Reserve Ratio: Not used as a policy tool; changed 3 times since 1980. Set at 10% (D>$50m); is it time to let go? is Goals of Monetary Policy Goals
• Inflation goals: Low/no inflation with limited year-to-year variability. • Output goals: High and stable economic (GDP) growth. • Employment goals: Stable employment growth with low unemployment. Intermediate Targets of Monetary Policy Intermediate
• The key rationale for intermediate targeting: key The limited long-term information about the information economy available to policymakers. Choosing an Intermediate Target Variable Choosing • Characteristics: Frequently observable observable Consistency with ultimate goals Definable and measurable measurable Controllable • Potential variables: Monetary aggregates Credit aggregates Interest rate Nominal GDP Exchange rates Federal Reserve Strategy Federal
• Target Bank Reserves: May target TR. May target NBR. May target BR. • Target Federal Funds rate: Pick an acceptable range and vary ER. Using rd means setting it below ff* and adjusting. Using OMO means buying/selling bonds. Reserve- versus Interest-Rate-Oriented Operating Procedures Procedures Figure 20–7 Targeting Monetary Aggregates Targeting
• Long Run link between MS growth and Inflation. Milton Friedman & money growth rule. ECB partly uses a money growth rule. • Eliminates discretionary policy. Lots of evidence that this is the source of disruption. • Eliminates “time consistency” problem. No more uncertainty about policy. • Acts as an “automatic stabilizer.” It builds in dampening effects on the business cycle. Targeting Interest Rates Targeting
Set interest rates to achieve goals . . . Using the Taylor Rule Using Calculate the target ff rate of interest: Calculate the target ff rate of interest: Explaining Policy - the Taylor Rule Explaining Federal Reserve Policies Federal
• 1970 - 1979 targets the Federal Funds rate. became increasingly inconsistent with money aggregate targets in the late 1970s. • 1979 - 1982 targets NBR. led to volatile interest rates and investment uncertainty. • 1982 - 1987 targets BR. essentially sets rd to maintain BR, controlling ff*. • 1987 - 2005 targets the Federal Funds rate. with “flexible” target ranges . . . meaning??? Is Policy the Right Choice? Is Time lags make effective policy uncertain. lags Discretionary policy promotes uncertainty (time inconsistency). Rules and credible adherence can eliminate credible bias. Independence is a likely key requirement. Time Lags in Monetary Policy Time
• Policy time lags Recognition lag Response lag Transmission lag Real GDP time Monetary Policy may be counterproductive Monetary
%∆ Real GDP time Ideally, policy would dampen the business cycle… If policy kicks in at the wrong time, it could worsen recessions and exacerbate inflationary periods. Discretion versus Rules Discretion (Milton Friedman)
• Discretionary policy is the source of instability. source • A policy rule can eliminate that instability. rule Set target for Bank Reserves, Monetary Base, Bank Monetary Money Supply to grow in LR sustainable fashion. Money This is a commitment to a fixed strategy no matter what happens to other economic variables. what • To be successful, the commitment must be credible. credible The public believes the Fed will act this way. Making Monetary Policy Rules Credible Credible
• Place constitutional limits on constitutional monetary policy. • Achieve credibility by establishing a reputation. reputation • Maintain central bank independence. independence • Establish central banker contracts. contracts • Appoint a “conservative” central banker. Targeting Inflation Targeting
• Inflation goals don’t constrain policy choices. Can alter interest rates, money supply, others. • This has become increasing popular. New Zealand in 1989; drove π down: 10% to 2%. • Fed hasn’t bought into it yet, but . . . Fed Bernanke has expressed interest in this. • Should help “anchor” expectations. It should be harder for inflationary expectations to change. • Does it de-emphasize output goals? Well . . . in the long-run, “No.” Annual Inflation Rates in the United States Annual SOURCES: Economic Report of the President, 2002; Economic Indicators (various issues). Figure 26–5 Targeting Inflation Targeting Making Monetary Policy Transparent Making Read FOMC minutes, press release and Ben’s speech. What Should the Fed Do? the
Policy Tools, Policy Objectives and Targets. Targets. ECO 473 - Money & Banking - Dr. D. Foster ...
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This note was uploaded on 10/22/2010 for the course ECO 473 taught by Professor Foster during the Spring '07 term at N. Arizona.
- Spring '07
- The Land