The Federal Reserve II. Fed Policy: tools & critique ECO 473 – Money & Banking – Dr. D. Foster

Monetary Policy: Goals & Targets Open Market Operations Discount Window Required Reserve Ratio (rrD) Price stability Low unemployment Sustainable growth Interest Rates Monetary Aggregates

Targeting the Federal Funds Rate of Interest Sept. 2017 1.15%

Time Lags in Monetary (& Fiscal) Policy Is Policy the Right Choice? Time Lags in Monetary (& Fiscal) Policy Policy time lags Recognition lag Response lag Transmission lag Real GDP Business cycle time

Monetary Policy may be counterproductive Is Policy the Right Choice? Monetary Policy may be counterproductive % Real GDP time Ideally, policy would dampen the business cycle… But, dampening the business cycle may lower ave. growth! Or, if policy kicks in at the wrong time, it could worsen recessions and exacerbate inflationary periods.

Discretion versus Rules (Milton Friedman) Discretionary policy is the source of instability. A policy rule can eliminate that instability. To be successful, the commitment must be credible. Making Monetary Policy Rules Credible Place constitutional limits on monetary policy. Achieve credibility by establishing a reputation. Maintain central bank independence. Appoint a “conservative” central banker.

Has the Fed maintained the value of the $? 4%

Making Monetary Policy Transparent FOMC Press Release Sept. 20, 2017 Q&A June 22, 2016 Presser Sept. 20, 2017

Quantitative Easing = Credible? QE 1 QE 2 QE 3

Can the Fed undo the QEs? Inflation is a monetary phenomenon. If economic growth is strong, will banks hold excess reserves? If banks greatly increase lending, what will happen to inflation? Can the Fed stop this by paying banks not to lend excess reserves? Once inflation starts, how fast will inflationary expectations change? What will happen if the Fed massively sells off MBS & UST? Survey: In the next five years, we will see: a. continued economic growth. b. rising and worsening inflation. c. recession. d. stagflation – recession coupled with inflation.

The Federal Reserve II. Fed Policy: tools & critique ECO 473 – Money & Banking – Dr. D. Foster