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Chapter 15- Monetary Policy What Is Monetary Policy?When initially created, the main responsibility of the Fed was to make discount loans to banks to prevent banks panics. As a result of great depression, Congress amended Fed Reserve Act to give the Fed responsibility of “promote effectively the goals of maximum employment, stable prices,and moderate long term interest rates.Monetary Policy refers to the actions the fed takes to manage money supply and interest rates.Goals of Monetary Policy•Price Stability•High Employment•Stability of Financial markets and institutions •Economic Growth Price Stability: rising prices erode the value of money as a medium of exchange and a store of value. Price stability remains a key policy goal of the Fed. High Employment: Unemployed works and underused factories and offices cause GDP to be below potential level. After WWII Congress passed the employment act which stated it was “the responsibility of the Federal Government…to foster and promote…conditions under which there will be afforded useful employment for those able and willing to work.” Because price stability and employment are explicitly mentioned in employment act, it is sometimes said that the Fed has a dual mandateto attain these goals. Stability of Financial Markets and Institutions: Resources are lost when financial markets are not efficient in matching savers and borrowers. Firms cannot get $$ needed to design and develop products and savers waste resources looking for satisfactory investments. A key difference between the great depression and the 2007-2009 recession is that the 2007-2009 events affected investment banks and commercial banks while the GD only affected commercial. Investment banks can be subject to liquidity problems b/c they often borrow short term-sometimes overnight- and invest the funds in longer-term investments. Commercial banks borrow from households and firms in the form of checking and savings deposits, while investment banks borrow from other financial firms such as investment banks, mutual funds etc. Just as commercial banks experience problems if depositors begin to withdraw funds, investment banks can experience problems if other financial firms stop offering short term loans. In 2008, Fed decided to ease liquidity problems that investment banks can temporarily receive discount loans, which were previously only a available to commercial. Economic Growth: Policymakers encourage stable economic growth b/c it allows households and firms to plan accurately and courage the long-run investment that is needed to sustain growth. Policy can spur econ. Growth by providing incentives for saving to ensure a large pool of investment funds, as well as providing direct incentives for firms to invest. Congress and Pres.
may be better able to increase saving and investment though, b/c they can change the tax laws to increase return on savings. The Money Market and the Fed’s Choice of Monetary Policy Targets