Lecture 16_Chapter 19

Lecture 16_Chapter 19 - 11/29/2011 Chapter 19 Chapter 19...

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11/29/2011 1 Chapter 19 Chapter 19 The Conduct of Monetary Policy: Strategy and Tactics Linking Tools to Goals/Objectives • Tools – OMO, Discount Loans, Reserve Req., Interest on Reserves • Operating (Policy) Instruments – Federal Funds Rate or Monetary base • Intermediate targets – ST and LT interest rates; Monetary Aggregates (M1 , M2), • Goals/Objectives: – Low Inflation, Growth, stable interest rates Linking Tools to Objectives Desirable Features of a Policy Instrument – Easily observable by everyone – Controllable and quickly changed – Tightly linked to the policymakers’ objectives Short-term interest rates are the preferred instrument of monetary policy used to stabilize short-term fluctuations in prices and output.
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11/29/2011 2 Linking Central Bank Tools to Objectives (Goals) Link #1 Link #2 Link #3 MB x m = M1 M1 x V = P x Y Monetary Targeting • The central bank announces that it will target a certain rate of growth in a monetary aggregate – For example, 5 percent growth in M1 • In the 1970’s adopted by a number of central banks – US, Germany, Canada, UK Monetary Targeting • United States – Fed began to announce targets for money supply growth in 1975. • Not very successful • Financial innovation – Paul Volker in 1979 stated the focused was on nonborrowed reserves, but he realized the Fed needed to raise interest rates to control inflation – Greenspan announced in July 1993 that the Fed would not use monetary aggregates as a guide for conducting monetary policy
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11/29/2011 3 Monetary Targeting • Advantages – Flexible, transparent, accountable – Almost immediate accountability • Disadvantages – Must have a strong and reliable relationship between the goal variable (inflation or nominal income) and the targeted monetary aggregate. – This relationship has been shown to be weak. • Velocity of money is not stable Inflation Targeting • Given the breakdown in the relationship between monetary aggregates and goal variables such as inflation and nominal income, a number of countries adopted inflation targeting as their policy strategy • Link #3 in the previous slide • Bypasses intermediate targets and focuses on final objective • Components: – Public announcement of numerical target – Commitment to price stability as primary objective – Frequent public communication Inflation Targeting
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11/29/2011 4 Inflation Targeting Public announcement of a numerical inflation target. Keep inflation low => keep inflation expectations low and stable Anchor long-term interest rates to promote growth. i = r + π e Hierarchical mandate – inflation first, everything else second. _____________________________________ Fed has a dual mandate. Has shied away from adopting
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This note was uploaded on 12/21/2011 for the course 1 1 taught by Professor 1 during the Spring '11 term at Université de Moncton.

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Lecture 16_Chapter 19 - 11/29/2011 Chapter 19 Chapter 19...

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