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Monetary Policy Goals, Strategy, Tactics. Week 10 (Chap 16). Three Tools of Monetary Policy. Open market operations Discount rate Reserve requirements. Open Market Operations. 2 Types 1.Dynamic: Meant to change MB 2.Defensive:

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Monetary Policy Goals, Strategy, Tactics

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Monetary Policy Goals, Strategy, Tactics

Week 10

(Chap 16)

Three Tools of Monetary Policy

  • Open market operations

  • Discount rate

  • Reserve requirements

Open Market Operations

2 Types


Meant to change MB


Meant to offset other factors affecting MB, typically uses repos

Advantages of Open Market Operations

1.Fed has complete control

2.Flexible and precise

3.Easily reversed

4.Implemented quickly

Discount Rate as Ceiling on Fed Funds Rate

Rightward shift of Rs to Rs2 moves equilibrium to point 2 where i2ff = id and discount lending rises from zero to DL2

Discount Rate


1.Lender of Last Resort Role


1.Confusion interpreting discount rate changes

2.Fluctuations in discount loans cause unintended fluctuations in money supply

3.Not fully controlled by Fed

Reserve Requirements


1.Powerful effect


1.Small changes have very large effect on Ms

2.Raising causes liquidity problems for banks

3.Frequent changes cause uncertainty for banks

4.Tax on banks

Quantity Equation


Money Growth and Inflation

Goals of Monetary Policy


  • Price Stability

  • Economic Growth

    3.High Employment

    4.Interest Rate Stability

    5.Financial Market Stability

    6.Foreign Exchange Market Stability

    Goals often in conflict

Time Inconsistency Problem

Rules versus discretion

Solution: Fixed Rules

Hierarchical Mandate

“The primary objective of the European System of Central Banks [ESCB] shall be to maintain price stability. Without prejudice to the objective price stability, the ESCB shall support the general economic policies in the Community.”

Dual Mandate

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run 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.”

1. M d fluctuates between M d' and M d''

2. With M-target at M*, i fluctuates between i' and i''

Money Supply Target

1.M dfluctuates between M d' and M d''

2.To set i-target at i* Ms fluctuates between M' and M''

Interest Rate Target

Criteria for Choosing Targets



3.Ability to predictably affect goals

Interest rates aren’t clearly better than Ms on criteria 1 and 2 because hard to measure and control real interest rates

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