Chapter 31 Notes - [ChapterThirtyOne MonetaryPolicy...

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[Chapter Thirty One] Monetary Policy Learning Objectives After reading the material in this chapter, you will be able to do the following: 1. Explain how monetary policy works in the AS/AD model. 2. Summarize the structure and duties of the Fed. 3. Describe how the Fed changes the supply of money primarily through open market operations. 4. Define the Federal funds rate and discuss how the Fed uses it as an intermediate target. 5. State the Taylor rule and explain its relevance to monetary policy. 6. Define the yield curve and explain how its shape reflects the limit of the Fed’s ability to control the economy. Chapter Outline Monetary Policy Monetary Policy: “A policy of influencing the economy through changes in the banking system’s reserves that influence the money supply and credit availability in the economy.” Monetary policy is controlled by the U.S. central bank, the Federal Reserve Bank (the Fed). How Monetary Policy Works in the Models Expansionary monetary policy shifts the AD curve to the right; contractionary policy shifts it to the left. Changes in nominal income will be split between changes in real income and changes in the price level. Figure 14- 1(a) shows this.
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In the long run, monetary policy affects only nominal income and the price level. This is shown in Figure 14-1(b). Expansionary monetary policy increases nominal income. %Δ Real income = %Δ Nominal income – %Δ Price level Figure 14-2(a) shows the supply and demand for money graph. The Fed undertakes monetary policy by changing the supply of money: expansionary monetary policy increases the supply of money (from M 0 to M 1 in the graph), which reduces the interest rate from i 0 to i 1 . This increases the supply of loanable funds, as shown in Figure 14-2(b). This lowers the interest rate that firms pay to borrow. Investment increases. Expansionary Monetary Policy: “A policy that increases the money supply and decreases the interest rate.” M i I Y Contractionary Monetary Policy: “A policy that decreases the money supply and increases the interest rate.” M i I Y How Monetary Policy Works in Practice Monetary Policy and the Fed Central Bank: “A type of banker’s bank whose financial obligations underlie an economy’s money supply.” The central bank in the U.S. is the Fed. The Fed’s ability to create money is what gives it the power to control monetary policy. In the United States, the central bank is not a part of the government. Structure of the Fed
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The Fed is composed of 12 regional banks along with the main bank headquartered in Washington, D.C. The Fed is governed by a seven-member Board of Governors.
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This note was uploaded on 12/03/2011 for the course ECON 101 taught by Professor Smith during the Fall '11 term at North Shore Community College.

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Chapter 31 Notes - [ChapterThirtyOne MonetaryPolicy...

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