Econ+102+lecture+17%2C+3-15-12+-+Theory+of+monetary+policy copy

Econ 102 lecture 17% - Required reading Ch 14 pp 397 399 Ch 15 pp 415 427 Ch 15 apdx pp 439 441 Ch 17 pp 476 479(may skip Ch 14's"the banking

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Lecture 17: Ch. 15, part 1 - Theory of Monetary Policy Econ 102, Winter 2012 3/15/2012 1 Required reading : Ch. 14: pp. 397 – 399 Ch 15: pp. 415 - 427 Ch 15 apdx: pp. 439 - 441 Ch 17: pp. 476 - 479 (may skip Ch 14’s “the banking system” pp. 400- 409)
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Outline 1. The Fed and the money supply 2. Money: from numeraire to real effects 3. Money Demand 4. Money Supply 5. Money market equilibrium 6. The casual pathway from money to rGDP 3/15/2012 2
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The Fed and the money supply 3/15/2012 3 We’ve discussed the structure of the Fed, and mentioned that it manipulates the money supply (via monetary base) How, exactly, can it do this? The Fed sets three major rates , and has one primary tool of monetary policy. The rates are: 1. The federal funds rate 2. The discount rate 3. Required reserve ratio The required reserve ratio is not used as a tool of Lower interest rates imply greater willingness to borrow Lower RRR implies a higher potential money multiplier
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The Fed and the money supply The federal funds rate (ffr) : the interest rate at which banks can borrow from other banks to cover very short-term gaps between actual reserves and required reserves The interest rate of the federal funds market . The Fed doesn’t directly control this rate, but it targets the ffr via monetary policy (ie, by changing the money supply) The discount rate : the rate from which banks can borrow overnight directly from the Fed Historically seen as a bad sign for banks to use it: interpreted as being desperate & unable to find willing lenders elsewhere 3/15/2012 4
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The Fed and the money supply The major monetary policy tool of the Fed (the FOMC): open market operations Open market operations (OMO) involve the Fed buying and selling U.S. Treasury bills (i.e. short- term shares of government debt) from commercial banks Never from the government directly – this would be taking “new” government debt and exchanging it for “new” money. Equivalent to printing money to pay the debt! A bad idea: can easily lead to hyperinflation How does trading debt equal monetary policy ? 3/15/2012 5
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The Fed and the money supply Recall the definitions of monetary base and the money supply Monetary base: currency in circulation or in bank reserves Money supply (M1): currency in circulation and checkable accounts (and travelers checks) In neither case did we mention the Fed at all! Currency held as an asset by the Fed is NOT in M1 or the monetary base Currency stored at the Fed but held as an asset by private banks IS part of the monetary base When the Fed pulls currency out of its asset reserves 3/15/2012 6
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The Fed and the money supply The Fed’s balance sheet (T-account) Assets: Treasury bills Liabilities: bank reserves held in Fed vaults (computers) Banks may withdraw at any time: a liability Consider the Fed’s actual balance sheet.
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This note was uploaded on 02/10/2012 for the course ECON 102 taught by Professor Rossana during the Winter '08 term at University of Michigan.

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Econ 102 lecture 17% - Required reading Ch 14 pp 397 399 Ch 15 pp 415 427 Ch 15 apdx pp 439 441 Ch 17 pp 476 479(may skip Ch 14's"the banking

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