Countercyclical monetary policy conducted by the

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Countercyclical Monetary Policy: Conducted by the central bank (FED), its objective is the dual mandate. Intermediate target of the FED; federal funds rate. Policy instruments of the FED; Open Market Operations. (Taylor Rule: the FED should raise the federal funds rate to 1.5% points for each 1% increase in the inflation rate. The FED should raise the federal funds rate to 0.5% points for each 1% increase in the output gap. Output gap = 100 X actual GDP – trend GDP/trend GDP). Countercyclical Fiscal Policy:
Automatic countercyclical tools. Tools that act against economic fluctuations, but need to explicit policy action (automatic stabilisers: unemployment insurance). Discretionary countercyclical tools. Tools that policy makers deliberately enact in response to economic fluctuations. 17 th – 34 th Monetary Policy Introduction Monetary policy is primarily concerned with the management of the key interest rates and the money supply in circulation, it is carried out by central bank. Tools of the monetary policy are the next: monitoring, regulating the financial intermediaries, controlling the key interest rates, but indirectly it can influence the money supply, the inflation and the long-term interest rates. Central bank does not have direct relationship with the public, only with the commercial banks. Most of the central banks have one goal, which is the price stability, except the USA – FED. The FED’s goal is the dual mandate, which includes price stability and the maximum (sustainable) level of employment. Fed has two dilemmas, 1 st fix reserves, but letting FED funds rate fluctuate. 2 nd fix the FED funds rate by supplying more – less reserves. When and What 1. If the central bank forecast that the inflation rate rises above the target, the central bank will increase the interest rate in order to moderate – control the economic growth, in order to slow down the growth. 2. If the central bank forecast that the inflation rate falls below the target, the central bank will decrease the interest rate, in order to boost up the economic growth. Open Market Operations 1. Buy = FED buys assets (usually treasury bonds) from intermediaries, in order to increase demand by lower the yield and less interest earned. FED pays with reserves (existing reserves), it means that more reserves will be in the circulation. The FED indirectly increased the money supply.
2. Sell = FED sells assets to intermediaries, in order to increase supply by higher the yield and higher interest earned. Buyers pay with reserves, it means that there will be less reserves in the circulation, less IOU and liquidity. The FED indirectly decreased the money supply. Types There are two types of monetary policy, it can be loose or tight monetary policy. During recession the loose monetary policy used, in this case the central bank wants to increase the money supply, by decreasing the interest rate and increasing the investments in consumption, and this will close the recessionary gap.

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