MONETARY POLICY AND THE DEBATE ABOUT MONETARY POLICY Part one.

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MONETARY POLICY AND THE DEBATE ABOUT MONETARY POLICY Part one

Laugher Curve A caveman points to two of his hairy relatives carrying clubs over their shoulders and says: “OK—you hunt, you gather, and I’ll fine tune the economy.”

Monetary Policy Real output Price Level Y2Y2 P0P0 P2P2 P1P1 Y0Y0 Y1Y1 Expan- sionary Contrac- tionary AD 0 AD 1 SAS AD 2

Effect of Monetary Policy on the Macro Policy Model Expansionary monetary policy shifts the AD curve to the right. Contractionary monetary policy shifts the AD curve to the left.

Effect of Monetary Policy on the Macro Policy Model Expansionary monetary policy increases nominal income. Its effect on real income depends on how the price level responds. %  Real Income = %  Nominal Income – %  Price Level

Monetary Policy and the AS/AD Model Monetary policy, controlled by the Fed, influences the economy through changes in the money supply and credit availability. Expansionary monetary policy shifts the AD curve to the right. Contractionary monetary policy shifts the AD curve to the left.

Expansionary Policy Beyond Potential Output Real output Price Level YPYP LAS B A P0P0 P1P1 SAS 1 SAS 0 AD 1 AD 0

Central Banks A central bank conducts monetary policy and acts as a financial adviser to the government. Central bank – a type of bankers’ bank. The central bank’s ability to create money gives it the power to control the money supply.

Structure of the Fed Chief policymaking body of the Federal Reserve System Open market operations Provides services Financial institutions Federal government Board of Governors of the Federal Reserve System 7 members appointed by the president and confirmed Chairman and vice chairman designated by the president and confirmed by the Senate Regional Reserve Banks and Branches 12 regional Federal Reserve banks 25 branches of Federal Reserve banks Oversees Federal Open Market Committee 7 members of the Board of Governors 5 Federal Reserve bank presidents

Structure of the Fed The Fed is a semiautonomous organization composed of 12 regional banks. The Fed has much more independence than most government agencies. The Fed does not rely on Congress for appropriations. Its governors serve 14 year terms and cannot be reappointed.

Federal Reserve Districts San Francisco Kansas City Minneapolis Chicago. Boston Richmond Atlanta St. Louis *Alaska and Hawaii are under the jurisdiction of the Federal Reserve Bank of San Francisco Dallas New York PhiladelphiaCleveland Washington DC

Duties of the Fed Conducts monetary policy Supervises and regulates financial institutions Lender of last resort to financial institutions Provides banking services to the U.S. government Issues coin and currency Provides financial services such as check clearing to commercial banks, savings and loan associations, savings banks, and credit unions.

The Importance of Monetary Policy The Federal Open Market Committee (FOMC) makes actual monetary policy decisions. The FOMC is composed of: The 7 members of the Board of Governors The president of the New York Fed A rotating group of 4 of the presidents of the other regional banks

The Conduct of Monetary Policy The Fed influences the amount of money in the economy by controlling the monetary base. Monetary base – vault cash, deposits of the Fed, and currency in circulation. Reserves – vault cash or deposits at the Fed Monetary policy affects the amount of reserves in the banking system. Reserves and interest rates are inversely related.