The Federal Reserve and Monetary Policy

Interest on Reserves Balances (IORB)
- Description: Interest paid on funds that banks hold in their reserve balance accounts at a Federal Reserve Bank
- In Practice: IORB serves as the Fed’s primary tool for guiding the Federal Funds Rate (FFR).
Overnight Reverse Repurchase Agreement (ON RRP)
- Description: The Federal Reserve’s offer to a broad set of financial institutions to deposit funds at the Fed and earn interest.
- In Practice: Acts as a supplementary tool; the ON RRP offering rate functions as a floor for the Federal Funds Rate.
Discount Window
- Description: Lending from the Federal Reserve to banks at the discount rate.
- In Practice: Helps establish a ceiling on the Federal Funds Rate.
Open Market Operations
- Description: The buying and selling of government securities by the Federal Reserve.
- In Practice: Crucial for ensuring that reserves remain ample.

Definition: The lowest rate that banks are willing to accept for lending out their funds.

Definition: The simultaneous purchase and sale of funds (or goods) to profit from differences in price.

Fed Funds Rate: The interest rate that depository institutions charge each other for overnight loans.
Discount Rate: The interest rate that Federal Reserve Banks charge for collateralized loans to depository institutions.
Influences: The Fed Funds Rate impacts short-term consumer loan interest rates—such as car loans, college loans, mortgage loans—US Treasury Securities, Corporate Bonds, and credit card rates.

Consumption Expenditures (C)
- Durable Goods: Includes items like automobiles and furniture.
- Trade-off: Balance between spending and savings.
Investment Expenditures (I)
- Details: Expansion and investment through corporate bonds or borrowing, household borrowing for new homes.
Government Expenditures (G)
- Note: Generally not sensitive to interest rate adjustments.
Net Exports (NX)
- Impact: US interest rates relative to those of other countries influence the inflow/outflow of investments in US financial assets. Higher US interest rates lead to increased foreign investment demand, raising the value of the dollar and subsequently decreasing exports while increasing imports.

Y = C + I + G + NX

Contractionary Monetary Policy: A strategy wherein the Federal Reserve increases the Fed Funds target interest rates to combat inflation.

Scenario: Expansion Phase with Inflation
- Current Conditions:
- Real GDP: $14.2 Trillion > Potential GDP: $14.0 Trillion
- Price Level: 102 (indicating inflation issue).
- Fed Actions:
- Increase the Fed Funds Target Interest Rate
- Options include raising interest rates or decreasing Money Supply.

Results in aggregate demand shifting left, decreasing price levels from 102 to 100 and aligning Real GDP with Potential GDP, thereby achieving price stability.

Expansionary Monetary Policy: A strategy wherein the Federal Reserve decreases the Fed Funds target interest rates to stimulate the economy, increase Real GDP, and decrease unemployment.

Scenario: Recession Phase
- Current Conditions:
- Real GDP: $13.8 Trillion < Potential GDP: $14.0 Trillion
- Price Level: 98, featuring high unemployment.
- Fed Actions:
- Decrease interest rates and/or increase Money Supply by purchasing Treasuries from banks.

Leads to an aggregate demand shift right, raising the price level from 98 to 100, indicating inflation, and allowing Real GDP to match Potential GDP, thus achieving high employment.

The Federal Reserve adopts a Counter-Cyclical Monetary Policy in response to economic conditions.
During inflationary periods, the Fed implements contractionary policies by raising administered interest rates or reducing the money supply.
Conversely, in high unemployment phases, the Fed employs expansionary policies by lowering administered interest rates or increasing the money supply.

While the Federal Reserve cannot entirely eliminate recessions, its interventions may mitigate the duration and severity of such economic downturns.

Indicators:
- Job growth has slowed, with a 2% increase in unemployment rates over the preceding quarter.
- Household spending has also slowed.
Monetary Policy Stance: A counter-cyclical expansionary monetary policy to address unemployment.

Indicators:
- Anticipated aggregate demand growth in 2006 is excessively high.
- Low inventories combined with heightened consumer demand.
Monetary Policy Stance: A counter-cyclical contractionary monetary policy to relieve inflationary pressures.

Select a narrowly defined macroeconomic topic for group work.
Discuss the topic with Prof Prantil for approval.
Assign research and presentation roles within the group.
Prepare for a group presentation consisting of 6-8 slides, requiring participation from all members and integration of quantitative analysis.