econmonetarismregulation - Day 11 Monetary Policy...

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Day 11 - Monetary Policy, Monetarism, Bank Regulation and Deregulation Monetary Policy How do changes in the money supply, and the price of money (the interest rate) affect the economy? Interest Rates and the Economy: Interest rates higher, firms borrow less for investment, Investment decreases, GDP falls Interest rates lower, firms borrow more for investment, Investment increases, GDP increases Keynes relied more on Fiscal policy. He expected that during times of depression there would be a liquidity trap : (Figure 17.3) No matter how much the money supply increased, there would be no change in the interest rate. -monetary policy does not help as much when economy is alright, but in recession, monetary policy isn’t as helpful when economy collapses and there is liquidity trap, no matter how much we lower interest rates (today, almost 0), people will still hold on to their money…not investing He also felt that during a recession business expectations could also negate the efforts of expansionary monetary policy…businesses don’t want to expand because of the business environment, regardless of interest rates. “Increasing the money stock to increase investment is much like pushing on a string” How the Fed Creates Currency/Reserves – How do they get into the economy? This is Monetary Policy. Fed has three primary tools to affect the money supply: Open Market Operations Buying and selling bonds in the capital market. Changing the Discount Rate The rate at which the Fed lends reserves to member banks… Fed Funds rate. .rate at which banks borrow from each other. .raising discount rate makes it harder for banks to make more loans (more reserves, more loans) Changing the Reserve Requirement The amount of reserves the FED requires banks to hold in reserve. The Fed uses these to create Monetary Policy : Increasing or Decreasing the money supply. In 2003,2004, 2005, FED tried to raise the discount rate, to limit the amount of money banks could loan to people, trying to prevent housing bubble, but banks kept loaning, housing bubble getting worse -when recession hit, FED tried to lower discount rates to encourage investment (2006, 2007, 2008) Federal Funds Rate: The rate banks borrow and lend reserves at on a very short term (usually overnight) basis. The FED targets this rate when it conducts its monetary policy. The most commonly used tool is Open Market operations. The other tools are rarely applied.
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The Federal Funds Market and Open Market Operations . The Fed Sells Bonds – Reserves in banking system Decrease: This is Contractionary Monetary Policy (interest rates are going up) The Fed Buys Bonds – Reserves in Banking System Increase: This is Expansionary Monetary Policy (Interest rates are going down) Monetarism: Like the Classical Economists (and unlike Keynesians) they use the equation of exchange from the Quantity Theory of Money : MV = PQ . (stuff produced x prices)GDP= output
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econmonetarismregulation - Day 11 Monetary Policy...

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