monetary policy

The Federal Reserve

created by Congress and instructed to promote maximum employment, while keeping inflation low and stable

interest rates

The Fed uses ____ ___ in an effort to influence economic conditions

raises

When the Fed ___ interest rates…

1. Induces people to spend less today

2. Reduces output

3. Reduces inflationary pressure

lowers

When the Fed ___ interest rates…

• Induces people to spend more today

• Increases output

high

the Fed sets real interest rates higher than the neutral interest rate when experiencing ____ inflation

low

the Fed sets real interest rates lower than the neutral interest rate when experiencing ____ inflation

higher

if actual output is higher than potential output, the Fed sets real interest rates ____ than the neutral interest rate

lower

if actual output is lower than potential output, the Fed sets real interest rates _____ than the neutral interest rate

Federal funds rate

= Inflation + Neutral Real Interest Rate + 1/2(Inflation - 2%) + Output Gap

monetary policy

the process of setting intererst rates in an effort to influence economic conditions

federal funds rate

the nominal interest rate the Fed uses as its policy tool

higher

increased demand for overnight loans —> ____ interest rates

the Floor Framework

how the Fed effectively sets a lower bound on how low the federal funds rate will go

lower

These two Fed Tools set the ____ bound:

1. pays interest to banks on their reserves

2. borrows money overnight from financial institutions and pays them interest on the loan

upper

This Fed Tool sets the ____ bound:

1. Lends directly through the discount window

increases; decreases; up

When the Fed sells bonds → ______ (increase/decrease) demand for overnight loans and _____ (increase/decrease) supply → federal funds rate is pushed ____ (up or down)

forward guidance

providing information about the future course of monetary policy to influence market expectations of future interest rates.

quantitative easing

the Fed’s strategy of purchasing large quantities of longer-term government bonds and other securities in an effort to put downward pressure on long-term interest rates, including mortgages

zero

tools the Fed uses when the federal funds rate is at _____

lender of last resort

the place financial institutions turn to when they need cash right away, but they’re having trouble getting a loan elsewhere