Lecture 14 - ECONOMICS 100B Professor Steven Wood 03/03/11...

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ECONOMICS 100B Professor Steven Wood 03/03/11 Lecture 14 ASUC Lecture Notes Online is the only authorized note-taking service at UC Berkeley. Do not share, copy, or illegally distribute (electronically or otherwise) these notes. Our student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. LECTURE: Today’s lecture will focus on Chapter 10: Monetary Policy and Aggregate and Demand. ICLICKER QUESTIONS/ANSWERS: 1.) If the central bank did NOT follow the Taylor principle, a rise in inflation would lead to a further increase in inflation. 2.) In 2008, both inflation and the real interest rate declined. This was caused by a decrease in autonomous spending and an easing in monetary policy. 3.) According to the liquidity preference theory, an increase in the price level would decrease the demand for real money balances. FEDERAL FUNDS RATE: Central banks use nominal short-term interest rates to conduct monetary policy. The Federal Reserve conducts monetary policy by setting a target federal funds rate. The federal funds rate is the interest rate that banks use on overnight loans of excess reserves (loans from bank to bank). The Fed uses open market operations to control the amount of reserves in the banking system, which then affects the federal funds rate. However, while central banks control short-term nominal interest rates, it is only real interest rates that matter for real economic activity. The Fisher equation says that r = i – π e . This tells us that changes in the nominal interest rate will affect the real interest rate only if expected inflation stays the same in the short-run. If prices are sticky, monetary policies that change short-term nominal interest rates won’t immediately affect either actual or expected inflation. As a result, changes in short-term nominal interest rates will change short-term real interest rates in the same direction. Central banks can thus control real interest rates in the short-term. However, this doesn’t mean that they can control them in the long- run (since all prices are flexible in the long-run). MP CURVE:
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This note was uploaded on 02/06/2012 for the course ECON 100A taught by Professor Woroch during the Fall '08 term at University of California, Berkeley.

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Lecture 14 - ECONOMICS 100B Professor Steven Wood 03/03/11...

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