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Unformatted text preview: 1 15-1 Monetary Policy and Aggregate Demand 15-2 Agenda 1. The Federal Reserve and Monetary Policy 2. The Monetary Policy Curve 3. The Aggregate Demand Curve 4. The Money Market and Interest Rates 15-3 The Federal Reserve and Monetary Policy • Central banks use nominal short-term interest rates as their primary policy tool. – The Federal Reserve conducts monetary policy by setting a target for the federal funds rate . 15-4 The Federal Reserve and Monetary Policy • The federal funds rate is the interest rate that banks lend to one another on an overnight loan of excess reserves. – Through open market operations the Fed can control the amount of reserves in the banking system and, thus, can control the fed funds rate. 2 15-5 The Federal Reserve and Monetary Policy • Central banks control short-term nominal interest rate but it is real interest rates that matter for real economic activity. • From the Fisher equation: – Changes in the nominal interest rate will affect the real interest rate only if expected inflation remains unchanged in the short-run. r = i – π e 15-6 The Federal Reserve and Monetary Policy • If prices are sticky , changes in monetary policy that affect short-term nominal interest rates will not have an immediate effect on either actual or expected inflation. – Thus, when central banks change nominal short- term interest rates, real short-term interest rates will also change in the same direction. 15-7 The Federal Reserve and Monetary Policy • The ability of central banks to control real interest rates in the short-term does not imply that they can control them in the long-run (when all prices are flexible). 15-8 The Monetary Policy Curve • The monetary policy curve, MP , represents the positive relationship between the real interest rate that the central bank sets and the inflation rate....
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This note was uploaded on 03/13/2012 for the course ECON 100B taught by Professor Wood during the Fall '08 term at Berkeley.
- Fall '08