The Federal Reserve has a dual mandate to:
This presentation is the property of its rightful owner.
Sponsored Links
1 / 21

The Fed manages Inter-bank Interest Rates and Regulates Banks…but does it control money supply? PowerPoint PPT Presentation


  • 78 Views
  • Uploaded on
  • Presentation posted in: General

The Federal Reserve has a dual mandate to: Maintain stable prices (fight inflation/deflation) Maintain full employment (monetary policy to manage macroeconomic conditions). The Fed manages Inter-bank Interest Rates and Regulates Banks…but does it control money supply?. Monetary Policy.

Download Presentation

The Fed manages Inter-bank Interest Rates and Regulates Banks…but does it control money supply?

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


The fed manages inter bank interest rates and regulates banks but does it control money supply

The Federal Reserve has a dual mandate to:Maintain stable prices (fight inflation/deflation)Maintain full employment (monetary policy to manage macroeconomic conditions)


The fed manages inter bank interest rates and regulates banks but does it control money supply

The Fed manages Inter-bank Interest Rates and Regulates Banks…but does it control money supply?


Monetary policy

Monetary Policy

"Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output... A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society."

--Milton Friedman

The Bank [of Canada] gave it a college try, it really did. It just doesn't work that way.

--John Crow, former governor of the Bank of Canada, on implementing Friedman's theories;


What is monetary policy

What Is Monetary Policy?

  • Central bank (as representative of government) manipulation of the

    • money supply,

    • interest rates

    • credit conditions

      with an objective of achieving macroeconomic goals.


Monetarist theory history the classical school strikes back at keynesianism

Monetarist Theory History – The Classical School Strikes Back at Keynesianism


Three theories of monetary policy

Three Theories of Monetary Policy

  • Strict Monetarist

  • Neo-classical/New Keynesian

  • Modern Monetary Theory (MMT)


Equation of exchange

Equation of Exchange

  • M x V = P x Y

    • M: money supply

    • V: Velocity

      • (how fast money is spent)

    • P: Price Level

    • Y: Real Income

    • Note: sometimes shown as M * V = P * Q same concept, different notation

  • Identity: Must be true for any period of time


Both monetarist and neo classical new keynesian theories

Both Monetarist and Neo-Classical/New Keynesian Theories:

  • Trade-off between unemployment and inflation exists

  • Controlling Inflation is higher priority


Money supply concept classical or milton friedman monetarist version

Money supply concept: (Classical or Milton Friedman Monetarist version)

Money supply is ‘exogenous’

  • more bank reserves —>

  • more lending by banks –>

  • increased money supply –>

  • lower interest rates –>

  • borrowing by consumers/firms –>

  • more C and I spending –>

  • faster GDP growth & inflation


Interest rates concept neoclassical version

Interest rates concept: (Neoclassical version)

  • central bank open market purchases of bonds –>

  • higher bond prices = lower interest rates –>

  • more borrowing by consumers/firms –>

  • more spending on C and I –>

  • faster GDP growth –>


But the equation of exchange

But, the Equation of Exchange

  • M x V = P x Y

    • M: money supply

    • V: Velocity (how fast money is spent)

    • P: Price Level

    • Y: Real Income

  • Note: sometimes shown as M V = P Q

    • same concept, different notation

  • Equation of Exchanges is an Identity: Must be true for any period of time after the fact..


Quantity theory of money qtm

Quantity theory of money (QTM):

  • Based on equation of exchange with added assumptions about the behavior of variables.

    • assume V is constant

  • Conclusions:

    • Money supply growth is solely responsible for determining Inflation


Crowding out theory

‘Crowding Out’ Theory

  • Assumptions:

  • Fixed amount of money in economy

  • QTM holds true

  • Theory: Gov borrowing takes $ away/raises interest rate for firm and household borrowers –> will reduce C and I unless

  • Central Bank increases M to fund deficit  inflation

  • Absolutely not supported by evidence or data in modern real world.


Current neoclassical and new keynesian views on monetary policy

Current Neoclassical and New Keynesian Views on monetary policy

  • Support for ad hoc policy (policy makers should make it up as they go)


Modern monetary theory mmt

Modern Monetary Theory (MMT)

  • Money growth (M1 – bank credit) is largely endogenous

  • Key is base money growth, not M1

    • government deficits enable the private sector (firms and households) to grow and yet still accumulate net financial assets


The fed manages inter bank interest rates and regulates banks but does it control money supply

MMT Foundation: Fiat money system with floating exchange rates eliminates government budget constraint

  • Deficits effective in fighting unemployment

    • no financing constraint on deficits

    • deficits are limited by the availability of real, unemployed resources for the government to purchase

  • Inflation threat is at/near full employment is reached (AD- LRAS model)


Limitations of monetary policy pushing on string

Limitations of Monetary Policy: ‘Pushing on string’

  • Central bank cannot force banks to make loans


Limitations of monetary policy endogenous money supply

Limitations of Monetary Policy: Endogenous money supply

  • Banks, not central bank really determine supply of money and credit


Limitations of monetary policy fiscal policy coordination

Limitations of Monetary Policy: Fiscal Policy Coordination

  • Fiscal and Monetary policy could work at cross-purposes

  • could expect ‘other’ to do it


Limitations of monetary policy liquidity trap

Limitations of Monetary Policy: Liquidity trap

  • At ‘zero lower bound’

    • when interest rates approach zero but the economy is still weak, monetary policy is largely ineffective.


Limitations of monetary policy globalization

Limitations of Monetary Policy: Globalization

  • If interest rates too low or inflation too high, then value of currency drops –> capital inflow drops and M drops, even though X rises


  • Login