Macro 33 notes

Monetary Policy Objective

Goals of Monetary Policy
1. Maximum employment(<6%, zero cyclical unemployment, only unnatural unemployment, frictional, structural, and seasonal production at potential GDP- fully employed)
2. stable prices inflation <3% (Fed's measure of inflation is the core inflation rate, which is the annual percentage change in the personal consumption expenditure deflator(PCE deflator) excluding the prices of food and fuel. Core inflation rate between 1 and 2 percent a year
3. moderate long-term interest rates
4. manage business cycle (steering a steady course between recession and inflation
5. Financial Stability

Monetary Policy objectives
The objectives of monetary policy are ultimately political.
The objectives are set out by the Board of Governors of the Federal Reserve System in as defined by the Federal Reserve Act of 1913 and its subsequent amendments.

Policy Trade offs:

Deregulating financial markets lead to increased risks in financial markets but leads to high economic growth and more jobs.

Regulating financial markets leads to reduced risks in financial markets but leads to slower economic growth and fewer jobs
Financial Markets privatize profits and socialize losses.

Federal Reserve Banking System
7 board members
14 year term
12 districts
Federal Open Market Committee meets eight times a year, every six weeks implements monetary policy (buy/sell bonds)
congress plays no role, it is semi-autonomous government agency
Publishes two reports yearly(beige book) on the condition of the economy

The formal role of the POTUS is limited to appointing the members and the Chairman of the Board of Governors

The Federal Reserve Act makes the Board of Governors of the Federal Reserve System and the FOMC responsible for the conduct of monetary policy.

Monetary policy
Changes in money supply and interest rates to influence real GDP in the economy.
Recession
Increase money and shift aggregate demand to the right.
Decrease interest rates= aggregate demand shift to the right
Inflation
Decrease money and shift AD to the left
Increase interest rates up= shift aggregate demand to the left

Aggregate demand=GDP

The price of monetary base is the federal funds rate.

Federal funds rate is the interest rate at which banks can borrow from the federal reserve bank.

Decrease federal funds(interest) rate- the fed must increase money supply- buy securities in the open market(reduced interest rates and combat recession/reduce unemployment)

Increase federal funds(interest) rate- the fed must decrease money supply- sell securities(increased interest rates and combat inflation/reduce borrowing)


Monetary Policy Combatting Recession
Decrease Federal Funds(interest) rate target
New York Fed BUYS securities in the open market
Other short-term interest rates FALL
Exchange rate FALLS
Quantity of money and supply of loanable funds INCREASE
Long term real interest FALLS
Consumption expenditure, investment, and net exports INCREASE
Aggregate demands INCREASE
Real GDP growth rate INCREASES
Inflation INCREASES

Monetary Policy Combatting Inflation
Increase Federal Funds rate target
NYF SELLS securities
Other short-term interest rates RISE
Exchange rate RISES
Quantity of money and supply of loanable funds DECREASES
Long term real interest RISES
Consumption expenditure, investment, and net exports DECREASE
Aggregate demand DECREASES
Real GDP growth rate DECREASES
Inflation rate DECREASES

Fed's decision making strategy

Instrument rule
The instrument rule is also known as the Taylor rule, and sets the federal funds rate by a formula that links it to the
current Inflation rate (<3%)
current estimate of the output gap(Real GDP)(>3%) recession
current estimate unemployment (<6%)

Targeting rule
A decision rule for monetary policy that sets the policy instrument(Federal Funds Rate) at a level that makes the central bank's forecast of the ultimate policy goals equal to their targets.
A monetary policy instrument rule.
1. A gold price targeting rule
2. Nominal GDP targeting is a monetary policy that makes the quantity of money grow at k percent per year, where k equals the growth rate of potential GDP (Friedman Rate of economic growth.
3. An inflation targeting rule, fix it at 2% and set your monetary policy based on it.

Monetary Policy

Advantages
No law-making time lag
Independent and managed by professionals
Quick and precise, every eight weeks(FOMC)

Disadvantages
Estimating potential GDP
Economic forecasting
Liquidity trap, investments may not respond to interest rates