chapter 5 note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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1 | P a g e Omar M. Al Nasser, Ph.D., MBA. Visiting Assistant Professor of Finance School of Business Administration University of Houston-Victoria Email: alnassero@uhv.edu Chapter 5 Monetary Policy Outline Mechanics of Monetary Policy Correcting a Weak Economy Correcting High Inflation Limitations of Monetary Policy Tradeoff in Monetary Policy Impact of Other Forces on the Tradeoff How the Fed’s Emphasis Shifted during 2001–2007 Proposals to Focus on Inflation Economic Indicators Monitored by the Fed Indicators of Economic Growth Indicators of Inflation How Monetary Policy Affects All Sectors Impact in Financial Markets Impact on Financial Institutions Integrating Monetary and Fiscal Policies Monetizing the Debt Monetary Policy in a Global Environment Impact of the Dollar Impact of Global Economic Conditions Transmission of Interest Rates
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2 | P a g e POINT/COUNTER-POINT: Can the Fed Prevent U.S. Recessions? POINT: Yes. The Fed has the power to reduce market interest rates, and can therefore encourage more borrowing and spending. In this way, it stimulates the economy. COUNTER-POINT: No. When the economy is weak, individuals and firms are unwilling to borrow regardless of the interest rate. Thus, the borrowing (by those who are qualified) and spending will not be influenced by the Fed’s actions. The Fed should not intervene, but should let the economy work itself out of a recession. WHO IS CORRECT? Use the Internet to learn more about this issue. Offer your own opinion on this issue. ANSWER: It is difficult to determine how long a recession would last if the Fed did not intervene. However, most people (especially the unemployed) would prefer that the Fed make an effort to stimulate the economy. There is some concern that a stimulative monetary policy may cause more inflation, but this is a risk that the Fed must take in order to cure a recession. Questions 2. Tradeoffs of Monetary Policy. Describe the economic tradeoff faced by the Fed in achieving its economic goals. ANSWER: In general, a stimulative monetary policy can increase economic growth and reduce unemployment, but may increase inflation. A restrictive monetary policy can keep inflationary pressure low but may cause low economic growth and higher unemployment. 3. Choice of Monetary Policy. When does the Fed use a loose-money policy and when does it use a tight-money policy? What is a criticism of a loose-money policy? What is the risk of using a monetary policy that is too tight? ANSWER: A loose monetary policy may be used to stimulate the economy, especially if inflation is not a concern. A tight monetary policy may be used to slow economic growth in order to reduce inflationary fears. A loose-money policy may result in higher inflation.
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This note was uploaded on 09/21/2011 for the course FINANCE 3321 taught by Professor Jianjundu during the Fall '11 term at University of Houston-Victoria.

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chapter 5 note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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