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I. The Demand for Money
A. Transaction 1, D1 results because people hold
money, often in
a money market account, to use as a medium of exchange.
B. Transaction 2 Asset Demand D2 results because people
accumulate money,
often held in an investment account, to buy assets and
other needs
C. The demand for money, Dm= Dt + Dt
D. For more information visit
Demand for Money - Wiki
E. Affecting the non-investment components of aggregate demand
1. Lower interest rates also increase C, G, and XN
a. Consumption increases as credit purchases become cheaper.
b. Refinancing existing debt at lower interest rates by
individuals,
businesses,
and governments frees funds for spending.
c. Lower interest rates also decrease the international value of the dollar
as
investors buy (demand) other currencies to earn more interest. The lower
dollar increases XN as U.S. goods are less expensive
and foreign
goods
more expensive.
2. Higher interest rates have an opposite affect
3. Currency Exchange Rates and Economic Activity
a. Value of a currency determines price of import and export goods
b. Increase in money supply cause inflation lowering the value of currency
making exports cheaper and imports more expensive.
c. Exports increase as they are less expensive in real terms and imports
decrease as conversion to yen makes Toyota's more expensive
d. Readings
1.
A strong Dollar is Always Good Except When It Isn't. 1/24/15
2.
U.S Government's Problem With a Strong High Valued Dollar 2/5/15
3.
A Brief History of U S Dollar Debasement 1/8/13
F. Federal reserve balance sheet.
1. Assets are held in
securities and loans to commercial banks.
2. Liabilities and net worth
are the reserves of commercial banks-
treasury deposits, federal reserve notes, equity-accumulated profits.
G.
Summary:
Monetary Policy
is the regulation of the money supply to
affect interest rates which
economic growth. |
Powell Tackles Coronavirus-19
Average ratio to GDP of unsecured
and
mortgage bank credit
Ratio of total mortgages to
total value
of U.S. housing stock
Source: Jordà, Schularick, and Taylor (2016).
See
Bubbles Credit And Their Consequences |
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II. Monetary Policy
A. Prelude:
A History of
US
Banking
B.
Monetary policy is the regulation of the money supply to affect interest
rates, economic activity, with the
objective of
noninflationary full employment.
1. It is part of, but not the focal point of
Keynesian economics.
2.Affecting interest rates and to change
investment thus affecting economic activity is one goal of the Fed.
a. Controlling reserve requirement may
affect the money supply which may affect
interest rates
1. Reserve requirement is the amount of
demand deposits that must be kept in cash with the FED or in the
bank.
2. Often expressed as a percent called
the reserve ratio.
3. Excess reserve can be loaned as demand
deposits.
4. Excess reserves determine the potential money supply
(M1).
b. Changes
interest rates change investment causing a change in AD which
changes economic activity.
1) Increasing the
money supply may lower interest rates. increasing investment
which increases AD which causes an increase in Real GDP.
2) Decreasing the
money supply may increase interest rates lowering investment which increases AD
which causes an increase in Real GDP.
c. Dollar values on this page are representative of
amounts prevalent during the late 1990's (billions of
dollars).
C. Types of monetary policy
1. Quantitative controls affect the
money supply.
a. Required Reserve Ratio
1. Lowering the reserve ratio
creates excess reserves which banks may loan as newly created money. This is
expansionary.
2. Raising the reserve ratio eliminates
excess reserve so banks can not renew loans removing money and causing a
contraction.
b. Open-market operations
1. Buying and selling of U.S.
government bonds by the Fed from banks or in the open market to change excess
reserves affecting M1 supply
and interest rates is the primary tool.
2. Buying bonds is expansionary.
a) When buying from banks, the
Federal Reserve pays with reserves providing excess reserves banks can loan as
demand deposits.
b) When buying in the open market,
increased demand from the Federal Reserve pushes up prices sellers
receive, lowering the effective
interest sellers pay.
3. Selling bonds contracts the economy.
4. Review of Valuing
bonds
a) Suppose you buy a twenty year, $10,000 bond paying 5%
per year at face value of $10,000. Face value is called par value.
1) A few years go by and you need money and one
choice is to sell the bond.
2) If interest rates on this type bond have gone
down, people will be very anxious to buy, demand, will be high pushing price up
and your will receive more than $10,000.
3) If rate shave gone down, no one will give you
$10,000, demand will be low, so if you need the money, you will sell for less,
below par.
4) You can hold for twenty years and get par and get
the money some where else.
b) Therefore, interest rates and bond values (prices) go
in the opposite direction, if interest rates down, old bond price up because
they are
at the old higher rate.
c) This is called the interest rate risk for bonds. Other
risks have to do with issuer default and monetary inflation.
5. It is the most powerful of the
four tools.
C. Discount rate
1. This is the rate charged by the
Federal Reserve for loans to member banks.
2. It strongly affects the prime
interest rate paid by a bank's best customers.
a) Lower the rate to expand economy
as interest rates decrease.
b) Raise the rate to contract
economy as interest rates increase.
c) Another important interest rate
is the federal funds rate which is the rate at which banks loan funds to
each other.
D. Term Auction Facility
1. Initiated in 2007, it allows banks to add to their
reserves at low rates.
2. Done to increase bank liquidity which was low because of a
loss in reserve caused by a housing crisis.
2. Other controls affect the actions of market
participants.
A. Moral suasion or jawboning is social
pressure by influential people to encourage specific people to act in the public
interest.
B. Margin
requirements, the down payment required on stocks which is now 50%, is
seldom changed.
C. Consumer credit
controls, on items such as credit cards, work so well it is seldom used.
D. The Federal Funds
Rate is the overnight rate banks with excess fed reserve charge each banks
short of fed reserve to keep the system in balance.
1. Most
controllable interest rate 2. Targeted by monetary policy 3. Controlling reserves, controls this rate. 4. Allows
some control over short-term rates.
D. Effectiveness of monetary policy
1. Strengths
a. Speedy,
flexible b. Somewhat
isolated from political pressure c. Hard money, restrictive policy by
the Federal Reserve, has worked well recently.
2. Weaknesses
a. Easy money has not
worked well because low business profit expectations , fears over employment
loss by workers make low interest rates ineffective.
b. Bank
deregulation has made commercial banks a less important supplier of investment
funds thus diminishing the effectiveness of monetary policy.
c. Changes
in the velocity of money may negate some of the effects of monetary policy.
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e.
Federal
Open Market Committee minutes make interesting reading.
f. It is the most powerful of the four tools.
g. Historical Note on lender of last resort type actions before there was
a central
bank began in response to the Panic of 1837 (U.S. first great
depression.
source
1. "The Secretary of the Treasury,
Salmon P.
Chase, bought $13.5 million in
National 5-20 bonds, but this tepid government response did little
to calm the markets (Juglar 95)." Tepid response would be used to
describe
FED actions during Great Recession.
2. "The New York Clearing House had two tools at its disposal for combating
banking panics and liquidity crises, in the form of loan certificates and
reserve pooling."
3.
Discount rate
a. This is the rate charged by the Federal Reserve for loans to member banks.
b. It strongly affects the prime interest rate paid by a bank's best
customers.
1) Lower the rate to expand economy as interest rates decrease.
2) Raise the rate to contract economy as interest rates increase.
3) Another important interest rate is the federal
funds rate which is the rate
at which banks loan funds to each other.
4.
Term Auction
Facility
a. Initiated in 2007, it allows banks to add to their reserves at low rates.
b Done to increase bank liquidity which was low because of a loss in
reserve
caused by a housing crisis.
5. Adjusting to The Great Recession
a.
How Fed Adjusted Tools to Combate Great Recession 1
b.
How Fed Adjusted Tools to Combate Great Recession 2
B. Qualitative controls affect the actions of market participants.
1. Moral suasion or jawboning
a. This social pressure by influential
people to encourage specific people
to act in the public interest.
b. It is used to influence public opinion and political attitudes.
c. An example is when the Chairman of Board of Governors makes his
Semiannual
Report to Congress on the economy and
monetary policy.
2.
Margin Requirements, the down payment required on stocks which is
now
50%, is seldom changed.
3.
Consumer Credit Controls credit cards work so well they are seldom used.
4.
The Federal Funds Rate
a. Most controllable
interest rate
b. Targeted by monetary policy
c. It is the overnight interest rate banks with excess fed reserve charge
each banks
short of fed reserve to keep the system in balance.
d. By controlling reserves, the fed controls this rate.
e. This allows them some control over short-term rates.
f. For more information visit
Federal funds rate - Wikipedia
g. Taylor rule
affected by Fed's
QE policies. 2/3/14
1.
Taylor rule would have
kept millions out of work (Minneapolis
Fed)
1/17
2.
A Taylor Rule for Public Debt
C.
Monetary Policy
Internet Game lets you be the FED chairperson.
D. Great Recession Brought New Tools
1.
Quantitative
Easing unconventional increases the money supply
2. Paying
higher interest on bank excess reserves
a. Limits effectiveness of excess bank reserves
b. In creases bank liquidity of banking system
3.
The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future
4.
9 Facts About the Great Recession and tools for fighting the next downturn
5.
Shrinking the FED' Balance Sheet/ 1/26/17
6.
Relying o the FED's Balance Sheet 2/25/18
E. Summary
Quantitative: affect
the money supply: with required reserve, open-market
operations, discount rate, term auction facility
Qualitative: affect financial
participation with moral suasion, margin requirements,
consumer credit
controls
F. Reading
1.
The Brave New World of Monetary Policy SF FED explains
policy change
resulting from the Great Recession 6/6/12
2.
The Post Keynesian View-of Monetary Policy 12/10/15
3.
Are The Effects Of Monetary Policy Asymmetric? Richman Fed 3/12/17
IV.
Implementing Monetary Policy
A.
Elements Of Monetary Policy Implementation Framework 1 of 4
B.
Counterparties And Collateral Requirements Of Implementing Monetary Policy
2 of 4
C.
How Do Central Bank Balance Sheets Change In Times Of Crisis Part
3 of 4
D.
The Trouble With Macroeconomics
centers on the failures of monetary policy
F.
The Long-Forgotten “M”
E. FED answers fiscal policy questions
1.
What is the money supply? Is it important?
2. What are the Federal Reserve's objectives in conducting monetary
policy?
3.
Why doesn't the FED just buy Treasury securities directly
from the U.S. Treasury?
4. Debt Monetization: Then And Now
4/14/18
5. American Capitalism after the Volcker Shock
Summary:
Internet articles on difficulty of implementing monetary policy
V. Effectiveness of Monetary
Policy
A.
Strengths
1. Speedy and
flexible
2. Somewhat
isolated from political pressure
3. Hard money,
restrictive Federal Policy, has
worked well recently.
B. Weaknesses
1. Easy money has
not worked well.
a. In the early 1900's, it didn't stop a recession.
b. Low profit expectations by business and fears
over possible employment loss by workers make
lower interest rates ineffective.
c. Interest rate cuts in 2001 were not able to stop
a recession as
borrowing as indicated by velocity slowed.
2. Bank deregulation has made
commercial banks a less
important supplier
of investment funds thus diminishing
the effectiveness of monetary
policy.
3. Changes in money
velocity may negate some effects
of monetary policy.
4. Fall in real
interest rates increase demand for fixed assets.
C.
Euro Monetary
Policy Failed
D.
The Coming War Between Trump & The Fed
8 min
video review/preview 4/14/17
E.
Inflation
Looming? Phillips Curve vs. Quantity Theory | Econbrowser
12/20
G. Summary:
Strengths: speedy, flexible, less political pressure, works well controlling inflation but with pain
Weaknesses easy doesn't spur enough growth,
velocity adjusts to
counter reserve changes.
Recent
Effectiveness
Source |
Hope FEDPrints
the Correct Amount
In the 1970's the World Began Competing
With US.
America was Forced to Adjust.
Nixon took US off Gold.
Companies/Unions Leaders Cooperated to Maximize wellbeing.
So Far So Good
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