MONETARY POLICY

MONETARY POLICY

QUANTITATIVE EASING, BONDS, 

WHAT IS OPEN MARKET OPERATIONS?

  • BONDS / SECURITIES—form of debt that the federal government issues (as well as notes, securities, etc.). They have principals, terms and interest rates just like any other loan

    • Bond prices have an inverse relationship with interest rates

  • Buying / selling govt securities

    • Treasury bonds, notes, bills, etc.

  • Key tool of monetary policy

MONETARY POLICY

  • Federal reserve has balance sheet with bonds that they already own. The rest of the economy (banks, individuals, mutual, funds, states, pensions, etc.) have bonds too

    • When the Fed wants to put more money into the economy, they buy bonds

    • When the Fed wants to slow down the economy, they sell bonds

  • Expansionary monetary policy, increasing the money supply

  • Contractionary monetary policy, reducing the money supply

KNOW HOW TO INCREASE & DECREASE THE MONEY SUPPLY

The government wants to contract the economy. What can they do?

  • Increase interest rates, reducing investment and consumption, and contracting the economy.

What happens to AD and Y (output)?

  • They both decrease 

QE (QUANTITATIVE EASING)

  • Expansionary monetary policy

Example of QE After the Mortgage-Meltdown

  • QE1 (Dec 08-Mar 10)

    • $1.25 trillion in mortgage-backed securities

    • $300 billion in treasury bonds

GRAPH THE MONEY MARKET

The demand for money is downward sloping because of the opportunity cost of money.

The Fed controls the money supply.

  • S = Money Supply

  • D = Money Demand

Money Supply and Demand and Nominal Interest Rates

MONETARIST VIEW ON MONETARY POLICY

Change monetary policy — Change in excess reserve — Multiple change in money supply — change in the interest rate —- change in investment — multiple change in GDP

In order for this to flow this way, there must be people willing to loan and people willing to borrow.

It’s a Wonderful Life (1946)

  • Bank run

    • When the bank closed, everybody was panicking and trying to pull their money from the bank, but as we saw, they have a fractional system and there was no cash in the bank

  • It was a mortgage loan bank