Limitations of Monetary Policy

Recap… First, let’s review the Tools of Monetary Policy

Tools of Monetary Policy Open-Market Operations (OMOs) Discount Rate Reserve Requirement

More Tools of Monetary Policy Margin Requirements – percentage of cash an investor must have to buy stocks, options, and other investments – prevents the occurrence of wild price fluctuations caused by overreliance on credit in the purchase of securities (speculation) – high margin requirements discourage investment in stock market, thus controlling inflation

More Tools of Monetary Policy Credit Regulation – usually occurs during times of nat’l emergency e.g., during WWII and Korean War, the Fed required high down payments and shorter repayment schedules for loans thus a decline in purchase of consumer goods and reduction in supply  allowed businesses to focus on production of war goods ability to do this was revoked in 1952

More Tools of Monetary Policy Moral Suasion – unofficial pressures that the Fed can exert on the banking system – uses letters, press conferences, testimony before Congress, etc. to direct lending policies of financial institutions.

Limitations Monetary Policy can only do what it’s designed to do, nothing more

Limitations Economic Forecasting – Prediction of future business activity and consumer spending is difficult – Incorrect forecasts can lead to incorrect policies Time Lags – Collecting and studying data takes months – Discussion of data and agreement on policy is time- consuming – Months pass before affect of policy is felt (ultimately, things may change during this time)

Limitations Priorities and Trade-offs – Monetary policy cannot do more than it is designed to do  fight inflation or recession – Some policies may remedy one problem and make another worse E.g., Easy Money=no recession, high inflation Tight Money=Recession, but no inflation

Limitations Lack of Coordination – Some gov’t agencies may have different goals than the Fed and it sends mixed signals to the market E.g., politicians may want to cut taxes while the Fed is trying to fight inflation Conflicting Opinions – Fighting within the gov’t (as above)

Practice Next, you will work on Federal Reserve, Money Supply, and AD/AS Practice FRQs Finally, your TOTD today is the Ch. 13 & 14 Crossword