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
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
Rightward shift of Rs to Rs2 moves equilibrium to point 2 where i2ff = id and discount lending rises from zero to DL2
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
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
4.Interest Rate Stability
5.Financial Market Stability
6.Foreign Exchange Market Stability
Goals often in conflict
Rules versus discretion
Solution: Fixed Rules
“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.”
“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''
1.M dfluctuates between M d' and M d''
2.To set i-target at i* Ms fluctuates between M' and M''
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