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UNIVERSITY OF CALIFORNIA, BERKELEY Dorian Carloni Department of Economics ECON 100B, Fall 2011 SECTION 14: Monetary Policy and Aggregate Demand 14.1. The Federal Reserve and Monetary Policy Central banks use nominal short-term interest rates as their primary policy tool. { In the U.S., the Federal Reserve conducts monetary policy by setting a target for the federal funds rate (a nominal rate!). It does so through open market operations, which allow the Fed to control the amount of reserves in the banking system and, thus, the fed funds rate. Central banks control short-term nominal interest rate but it is real interest rates that matter for real economic activity. { remains unchanged in the short-run. { This is true if prices are sticky (i.e. in the short run), in which case changes in monetary policy expected in±ation. { 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 ±exible). The monetary policy curve, MP, represents the positive relationship between the real interest rate that the central bank sets and the in±ation rate (by following the Taylor principle):
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This note was uploaded on 03/18/2012 for the course ECON 100B taught by Professor Wood during the Spring '08 term at University of California, Berkeley.

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