MONETARY POLICY OPERATED BY THE FEDERAL RESERVE GOALS: PROMOTE PRICE STABILITY (LOW INFLATION) PROMOTE FULL EMPLOYMENT (LOW UNEMPLOYMENT RATE)
Dec 15, 2015
MONETARY POLICY
OPERATED BY THE FEDERAL RESERVE
GOALS: PROMOTE PRICE STABILITY (LOW INFLATION) PROMOTE FULL EMPLOYMENT (LOW UNEMPLOYMENT RATE)
TOOLS USED BY THE FEDERAL RESERVE
CHANGING THE REQUIRED RESERVE RATIO (% OF DEPOSITS, OR RESERVES) KEPT IN THE VAULT
CHANGING THE INTEREST RATES THE “FED” CONTROLS
CHANGING THE MONEY SUPPLY
TO FIGHT A RECESSION, THE FED WOULD:
LOWER THE REQUIRED RESERVE RATIO – GIVES BANKS MORE RESERVES TO LOAN
LOWER THE FED’S TWO INTEREST RATES IT CONTROLS * borrowing from the Fed * interbank lending
BOTH MOVES DESIGNED TO STIMULATE BORROWING AND SPENDING
BUT THE FED’S BIGGEST TOOL IS MONEY CREATION
FED WILL PRINT MONEY IN HOPES PEOPLE WILL SPEND IT – THEREBY INCREASING SALES FOR BUSINESSES AND MOTIVATING BUSINESSES TO HIRE MORE WORKERS
FED’S RECENT MONETARY POLICY
2007, I
2007, III
2008, I
2008, III
2009, I
2009, III
2010, I
2010,III
2011, II
2011, IV
2012, II
2012, IV0
500
1000
1500
2000
2500
0
1
2
3
4
5
6
M base fed fd rt
$ bils. %
IF FED THINKS THE ECONOMY NEEDS TO BE SLOWED – EXPANDING TOO FAST:
“TAKING AWAY THE PUNCH BOWL”
INCREASE THE REQUIRED RESERVE RATIO
INCREASE INTEREST RATES
REDUCE THE AMOUNT OF MONEY IN CIRCULATION
RESULT – FEWER LOANS AND SPENDING
ISSUES WITH MONETARY POLICY
FED CAN MOVE QUICKLY IN IMPLEMENTING ITS POLICIES
BUT POLICIES TAKE TIME TO HAVE AN IMPACT – ANYWHERE FROM 12 TO 18 MONTHS
REASON – WORKS THROUGH THE LENDING PROCESS
ALSO, FED POLICIES CAN “BACKFIRE”
“EASY” MONEY POLICY CAN LEAD TO HIGHER INFLATION AND INVESTMENT “BUBBLES
* EASY MONEY IN EARLY 1970S LEAD TO HIGH INFLATION OF LATE 1970S * EASY MONEY OF EARLY 2000s LED TO HOUSING BUBBLE ?
ALSO, A “TIGHT” MONEY POLICY CAN:
RAISING INTEREST RATES AND CUTTING THE MONEY SUPPLY CAN LEAD TO A RECESSION
* VOLCKER AND RECESSION OF EARLY 1980S * GREEENSPAN/BERNANKE BEGAN RAISING INTEREST RATES IN LATE 2004 – CAUSED HOUSING BUBBLE TO “POP”?
FED HAS SPARKED CONTROVERSY
SOME SAY “END THE FED”
* COMMON CURRENCY BACKED BY GOLD * MUCH HIGHER REQUIRED RESERVE REQUIREMENTS * PRIVATE INSURANCE FOR DOPOSITS
BOTTOM LINE: MONETARY POLICY IS VERY POWERFUL
BUT, FED HAS TO WORRY ABOUT WINNING THE CURRENT BATTLE YET LOSING THE NEXT
NOBEL PRIZE WINNING ECONOMIST MILTION FRIEDMAN OFTEN SAID THE FED’S BACK AND FORTH POLICIES (EASY FOLLOWED BY TIGHT, ETC) LED TO MORE VOLATILE BUSINESS CYCLES
ISSUES HAVE COME TO FOREFRONT WITH “TOO BIG TO FAIL”
“Moral Hazard” – if banks know will be “bailed out”, will take more risk?
Possible solutions? * let them fail – but brings down entire economy? * restrict lending and investments - but hinders economic growth? * restrict size of banks – but lose some advantages; business goes to foreign banks?