Monetary Policy
refers to actions that the Federal Reserve System takes to change interest rates and the money supply. it is aimed at affecting the economy.
Central Bank
a bank for banks. The United States' central bank is the Federal Reserve System.
- a central bank that would regulate credit conditions was not a luxury but a necessity
- U.S. should have not one central bank, but twelve
- the central banks are more like
Central Bank Independence
refers to the central bank's ability to make decisions without political interference
- without independence, politicians might try to force the central bank to expand the money supply too rapidly before elections -> chronic inflation
- INDEPENDENCE = LOW
Open Market Operations
refers to the Fed's purchases or sales of government securities, normally Treasury bills, through transactions in the open market
- occurs when the Fed wants to change interest rates
- low interest rates = more reserves
- when the fed wants to lower inter
The Federal Funds Rate
the interest rates that banks pay and receive when they borrow reserves from one another
- those with excess reserves lend them to those with reserve deficiencies
- rate that applies when banks borrow and lend reserves to one another
- banks with excess r
Open-Market Operations, Bond Prices, and Interest Rates
- more demand for T-bills = rising prices for Treasury bills (T-bills) because of falling interest rates
- when bond prices rise, interest rates fall because the purchaser of a bond spends more money than before to earn a given number of dollars of intere
Which Interest Rate?
Relationships among interest rates broke down spectacularly during financial crisis because securities and loans differ in their risk of default
- risky borrowers pay higher interest rates than safer borrowers, in order to persuade lenders to accept the h
The Risk of Default
on any loan or security is the risk that the borrower may not pay in full or on time
Risk Premium (spread)
market interest rates generally include a risk premium to compensate the lender for the probability of loss if the borrow fails to repay the loan in full time or on time
- Risk interest rate = risk-free (treasury) interest rate + risk premium
- when the p
Discount Rate
is the interest rate the Fed changes on loans that it makes to banks
Other Instruments of Monetary Policy
1) Lending to Banks
- lender of last resort when risky business prospects made commercial banks hesitant to extend new loans or when banks ran into trouble
- Discount Rate - Federal Reserve officials can influence the amount banks borrow by altering the r
Unconventional Monetary Policy
is a generic term referring to unusual forms (or volumes) of central bank lending and to unusual types of open-market operations
Quantitative Easing
refers to open-market purchases of assets other than Treasury bills
How Monetary Policy Works in Normal Times
- Expansionary Monetary Policy (an open-market purchase of T-bills) -> lower interest rates
- Contractionary Monetary Policy (an open-market sale) -> raise interest rates
Investment and Interest Rates
- higher interest rates lead to lower investment spend
Money and the Price Level
Aggregate Supply
Expansionary monetary policy normally causes some inflation. But exactly how much inflation it causes depends on the slope of the aggregate supply curve
Why Aggregate Demand Slopes Downwards
at higher price levels, the quantity of bank reserves demanded is greater. If the Fed holds the supply schedule fixed, a higher price level must therefore lead to higher interest rates. Because higher interest rates discourage investment, aggregate quanti