Macro Chapter 14 Presentation 2- Expansionary and Restrictive Monetary Policy

Expansionary Monetary Policy (Easy $$) Used when the economy is facing recession and unemployment The Fed will announce a lower target rate for the Federal Funds rate They will use open market operations to buy bonds which will increase M and decrease the interest rate This will bolster borrowing and spending, which will increase AD and output

Targeting the Federal Funds Rate Federal Funds Rate, Percent 3.5 Quantity of Reserves DfDf target target Q f3 Q f1 Q f2 Using Open Market Operations To Set The Federal Funds Rate

Monetary Policy Expansionary Monetary Policy Problem: Unemployment and Recession Fed Buys Bonds, Lowers Reserve Ratio, or Lowers the Discount Rate Excess Reserves Increase Federal Funds Rate Falls Money Supply Rises Interest Rate Falls Investment Spending Increases Aggregate Demand Increases Real GDP Rises CAUSE-EFFECT CHAIN

Restrictive Monetary Policy (Tight Money) Occurs during times of inflation Higher targeted Federal Funds Rate Increases the interest rate to reduce lending and spending--- lowers money supply Reduces AD and holds down price level increases

Monetary Policy Restrictive Monetary Policy Problem: Inflation Fed Sells Bonds, Increases Reserve Ratio, or Increases the Discount Rate Excess Reserves Decrease Federal Funds Rate Rises Money Supply Falls Interest Rate Rises Investment Spending Decreases Aggregate Demand Decreases Inflation Declines CAUSE-EFFECT CHAIN

Advantages of Monetary over Fiscal Policy 1. Speed and flexibility- don’t have to wait for Congress 2. Isolation from political pressure

Problems with Monetary Policy 1. Lags (recognition and operational) 2. Cyclical Asymmetry- highly effective in slowing inflation but not necessarily for ending a recession because banks won’t always lend more money