ECO3200 Chap 9

What is the Taylor rule?

A notion summarizing how central banks set interest rates in response to deviations of output and inflation from desired levels.

What is the key interest rate set by the Fed?

The federal funds rate.

What happens when interest rates are raised?

It tends to cool off the economy.

What does lowering interest rates encourage?

Greater investment spending and spending on consumption goods, increasing aggregate demand (AD).

What are the main goals of central banks in short run policy?

To maintain high economic activity and low inflation rates.

What does the Fed's open market committee do?

Meets every 6 weeks to set the federal funds rate.

How does the Fed implement policy changes?

By buying and selling Treasury bills to lower or raise interest rates.

What effect do higher interest rates have on aggregate demand?

They raise the opportunity cost of purchasing goods for investment and consumption, reducing demand.

What is the result of expansionary monetary policy?

An increase in the quantity of money and a decrease in interest rates.

What occurs during contractionary monetary policy?

Higher interest rates lead to reduced borrowing and increased saving, causing the aggregate demand curve to shift inward.

What occurs when interest rates are lowered?

Prices and output typically increase, shifting the aggregate demand curve outward.

What conflict exists for central banks?

The conflict between their preferences for economic activity and their capabilities in controlling inflation.

What happens when the Fed raises interest rates?

The aggregate demand curve shifts to the left.

What does the liquidity preference model explain?

How the Fed's actions can change interest rates through alterations in the money supply.

What is the result of contractionary monetary policy in an overheated economy?

It increases interest rates making borrowing more expensive and encourages saving.

What is inflation targeting?

When monetary policy focuses more on controlling inflation rather than just boosting economic activity.