these things make up the shadow banking system • when housing prices decreases leveraged loans mean huge losses. • faiulre of Lehman brothers was the big set o ff with the worsening credit crunch • Fed set up the troubled asset relief program by providing funds to ban in exchange for stock • they directly bought commercial paper since 1930 • goal of monetary policy : price stability (low inflation) 1. high employment 2. stability of financial market and institutions (to promote e ﬃ cient flow of funds from saver to 3. borrower) economic growth 4. Money demand and suuply Monetary policy targets GDP, employment, and price level • The interest rate is on the vertical axis and the quantity of money is on the horizontal axis. We • use M1 here (currency + checking) We hold money that has a low interest rate. The opportunity cost of holding money (in your • hands) is you could be investing it and making interest. The opportunity cost is the interest rate Any money is things like US treasury bonds help move along the curve. When interest rates rise • households loos money and when they fall we gain money The federal interest rate on OMO is very important for monetary policy. • Demand shifts • If real GDP increases the demand curve shifts RIGHT if real GDP decreases the demand curve shifts LEFT
if the price level increases the demand curve shifts RIGHT if the price level decreases the demand curve shifts LEFT supply shifts • in the fed wants to decrease money supply they OMS shifts left if the fed wants to increase money supply they OMP shift right change in interest rate do not e ff ect the money supply • when the fed increases the money supply the short term interest rate will fall. • when the interest rate on treasury rise, real interest rate on mortgagee loans rise • suppose AD shifts left because consumer confidence is down in a recession • suppose AD shifts right because because there is overheating and inflationary pressure • Monetary policy and economic activity federal fund rate is short term and nominal so it can be hard to predict if it a ff ects long term • interest rates
expansionary policy (loose easy) FOMC orders an expansionary policy 1. money supply increases and interest rates fall 2. investment, consumption and net exports increase 3. AD curve shifts right 4. real GDP and price level rise 5. contractionary policy (tight) FOMC orders a contractionary policy 1. money supply decreases and interest rates rise 2. investment, consumption, and net exports decrease 3. AD curve shifts left 4. Real GDP and price level fall 5. liquidity trap is when federal interest rate are lowered to 0 and can not go further • quantitive easing involves buying securitize beyond short term treasury securities usually • involved in open market. The fed purchased 10 year treasury notes and mortgage back securities challenges on monetary policy are the incoming data consistent with our forecasts or is it moving away from the forecast • recognition lag is the time between when a significant change in the economy performance • occurs and policymakers recognition of it policy lag
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