Professional Documents
Culture Documents
Goals
Intermediate Monetary
Instruments
Policy
Targets
Discretion
Instruments refer to the policy options the
Fed has to control the supply of money…
Reserve Requirements
Reserve Requirements
This is the most influence the ability of
often used banks to create new loans
instrument! which affects the broader
aggregates (M1,M2,M3)
Monetary Policy goals address the central bank’s
agenda in general terms
Price Supply
Price Supply
Target
Range
Price Supply
4%
Md(y,t)
M
P
Change in M2 = $2,000
Suppose that the Fed is Targeting the
Interest Rate at 5%
M2 Multiplier = 8
Change in M2 = $1,000
During the late 70’s, the federal reserve changed its policy
from an interest rate target to a money target. The money
target was abandoned in the mid eighties.
25
20
15 Fed Funds
Discount
10 Prime
0
Jan-70
Jan-72
Jan-74
Jan-76
Jan-78
Jan-80
Jan-82
Jan-84
Rules vs. Discretion
Should the Federal Reserve “pre-commit” to a particular course of
action?
US Treasury
A Gold Standard has two rules: Assets Liabilities
The government sets an
200 oz. Gold $10,000 (Currency)
official price of gold ($35/oz)
@ $35/oz
The government guarantees
$7,000 (Gold)
convertibility of currency into
gold at a fixed price $3,000 (T-Bills)
During most of the gold standard era, the Government had a reserve
ratio of around 12%
By committing to convertibility at $35 an ounce, the government
restricted its ability to increase/decrease the money supply
US Treasury (P = $35%)
US Treasury (P = $35%)
Price Supply
Assets Liabilities
200 oz. Gold $10,000 (Currency)
@ $35/oz
$7,000 (Gold) $35
$3,000 (T-Bills)
Demand
Q
Reserve Ratio = 70%
s
M
k (i, t ) y
P
With a (relatively) fixed supply of money, prices remained stable in the
long run
The gold standard and the supply of gold:
US Treasury (P = $35%)
Price Supply
Assets Liabilities
200 oz. Gold $10,000 (Currency)
@ $35/oz
$7,000 (Gold) $35
$3,000 (T-Bills)
100 oz. Gold
@ $35/oz $3,500 (Currency) Demand
Q
Reserve Ratio = 70%
From time to time, new gold deposits were discovered. This increased
supply would push down the market price. In response, households
would buy the cheap gold and sell it to the Treasury for $35. This would
increase the money supply.
The gold standard and the business cycle:
US Treasury (P = $35%)
Price Supply
Assets Liabilities
200 oz. Gold $10,000 (Currency)
@ $35/oz
$7,000 (Gold) $35
$3,000 (T-Bills)
Q
Reserve Ratio = 70%
i i S
Ms
4% 4%
I + (G-T)
Md
M Loanable
Funds
P
During the late 90’s, rapid income growth and productivity raised
consumer spending (savings falls) and raised investment spending.
Higher spending raised the demand for money. As unemployment
dropped to 4.5% (above capacity), prices began to rise.
Case study: Productivity Growth during the
late 90’s
i
i S
Ms
4% 4%
I + (G-T)
Md
M Loanable
Funds
P
2.5
3.5
4.5
5.5
6.5
Jan-94
May-94
Sep-94
Jan-95
May-95
Sep-95
Jan-96
May-96
Sep-96
Jan-97
Late 90’s Expansion
May-97
End of 1992 Recession
Sep-97
Jan-98
May-98
Sep-98
Jan-99
May-99
Sep-99
Jan-00
May-00
Stock Market Bubble
Asian Financial Crisis
Discount
Fed Funds
Case study: Stock Market Crash and
Liquidity Shocks
i
i S
Ms
4% 4%
I + (G-T)
Md
M Loanable
Funds
P
4% 4%
I + (G-T)
Md
M Loanable
Funds
P
Lowering the Fed funds target allowed the fed to increase the money
supply and stimulate spending.
Stock Market Crash
Beginning of Recovery?
Recession of 2001
7
6
5
4 Fed Funds
3 Discount Rate
2
1
0
Apr-00
Apr-01
Apr-02
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Oct-00
Oct-01
Oct-02