Monetary Policy Objectives and Framework. Federal Reserve Act of 1913 states:
Federal Reserve Act of 1913 states:
The Fed and the FOMC shall maintain long-term growth of the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
Equation of exchange:
Goals of Monetary Policy
The GDP Gap
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis. The GDP gap is the difference between real GDP and its estimated potential level.
Fed funds rate rises during expansions and is cut during recessions.
To adjust FFR, Fed tends to increase growth of monetary base during recessions.
The Fed could adopt either
FFR = 2 + INF + 0.5(INF – 2) + 0.5GAP
FFR will increase if inflation rises or GDP-gap rises
When the Fed lowers the federal funds rate:
When the Fed raises the federal funds rate, the ripple effects go in the opposite direction.