1. Llad Phillips1 Introduction to Economics Macroeconomics The US Economy

2. Llad Phillips2 Outline: Lecture Nine Macroeconomic Policy Macroeconomic Policy  Monetary Policy Review of Macro: O’Sullivan and Sheffrin Review of Macro: O’Sullivan and Sheffrin

3. Llad Phillips3 How Effective Has the Fed Been? Fed Goals: A Stable Economy Fed Goals: A Stable Economy  maximum employment  stable prices  moderate long-term interest rates Fed Objectives or Targets Fed Objectives or Targets  quantity of reserves  price of reserves: Federal Funds Rate  federal funds rate, FFR, is the interest rate banks charge one another for borrowing reserves for a day or so; mostly large urban banks borrowing from small suburban and rural banks

6. Llad Phillips6 Monetary Policy Tradeoff Is the Fed too Inflation Oriented? Is the Fed too Inflation Oriented? Note: the CPI inflation rate tends to decrease during and after recessions Note: the CPI inflation rate tends to decrease during and after recessions  to control inflation, the Fed may be tempted into policies that precipitate recessions and/or make them more severe Note: the unemployment rate tends to increase during and after recessions Note: the unemployment rate tends to increase during and after recessions  some critics in Congress think the Fed is too restrictive, i.e. not sufficiently expansionary in policy

7. Llad Phillips7 How Effective Has the Fed Been? Fed Objectives or Targets Fed Objectives or Targets  quantity of reserves  price of reserves: Federal Funds Rate  federal funds rate, FFR, is the interest rate banks charge one another for borrowing reserves for a day or so; mostly large urban banks borrowing from small suburban and rural banks

8. Llad Phillips8 Impact of the Supply of Reserves on the Federal Funds Rate FFR, price of reserves quantity of reserves Demand for Reserves by Banks Supply of Reserves: Fed

9. Llad Phillips9 Impact of the Supply of Reserves on the Federal Funds Rate FFR, price of reserves quantity of reserves Demand for Reserves by Banks Supply of Reserves: Fed

10. Fed Policy Target: Quantity of Reserves Millions http://www.bog.frb.fed.us/releases/H3/hist/h3hist1.txt

11. Fed Policy Target: Price of Reserves

12. Llad Phillips12 Observed Decline of the Nominal FFR During Recesssions During a recession, the Fed should be following an expansionary monetary policy, buying Treasuries, and expanding reserves During a recession, the Fed should be following an expansionary monetary policy, buying Treasuries, and expanding reserves  the increased supply of reserves should tend to decrease the price of reserves, i.e. the FFR During a recession, the inflation rate falls, and consequently, so will the nominal Federal Funds Rate During a recession, the inflation rate falls, and consequently, so will the nominal Federal Funds Rate Difficult to distinguish these two effects Difficult to distinguish these two effects

13. Llad Phillips13 Other Measures of Fed Effectiveness Reserve Aggregates Reserve Aggregates  Excess Reserves  Free Reserves

14. Llad Phillips14 Deposits with Fed Loans from Fed, OMO Fed Banks + Bank Vault Cash = Total Reserves Banks Bank Deposits Consumers Businesses x Reserve ratios = = Required Reserves -= Excess Reserves Consumers, Firms, Banks, and the Fed Determine Reserve Aggregates Fed

15. Fed Policy Record, 48.01-97.07 Source: Survey of Current Business, January, 1995

16. Llad Phillips16 Fed Monetary Policy: Insufficient Excess Reserves? Expansionary Policy Expansionary Policy  ease credit  provide positive free reserves Contractionary Policy Contractionary Policy  tighten credit  force banks to borrow at discount window, causing negative free reserves

17. Llad Phillips17 Bank Reserve Aggregates, 10-21-98 * Excess Reserves = Total Reserves - Required Reserves ** Free Reserves = Excess Reserves - Borrowed Reserves Source: TheWall Street Journal, Friday 8-22-97, p.C 18

18. Fed Policy Record, 48.01-97.07 Source: Survey of Current Business, January, 1995

19. Fed Policy: 48.01-97.07

20. Llad Phillips20 Fed Loans of Reserves to Banks Before each recession, Fed loans peak and exceed excess reserves Before each recession, Fed loans peak and exceed excess reserves As a consequence, free reserves are negative before each recession As a consequence, free reserves are negative before each recession  recall: free reserves = excess reserves - Fed loans  negative free reserves are called “net borrowed reserves”  they are an index of the Fed trying to tighten credit  evidently the Fed was tightening credit sufficiently to contribute to the recession Note: Fed keeps excess reserves low during inflationary 70’s; opposite policy in the 90’s Note: Fed keeps excess reserves low during inflationary 70’s; opposite policy in the 90’s

21. Llad Phillips21 US Postwar Expansions 90

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23. Llad Phillips23 Midterm Review O’Sullivan and Sheffrin O’Sullivan and Sheffrin  Ch. 20, 21, 24, 25, 27

24. Llad Phillips24 20: The Big Ideas in Macro Measuring the Output of the Economy Measuring the Output of the Economy Unemployment Unemployment Inflation Inflation Keynesian Economics: Controlling the Business Cycle Keynesian Economics: Controlling the Business Cycle  booms can lead to inflation  recessions can lead to unemployment

25. Llad Phillips25 21: Behind the Economic Statistics Expenditure Perspective: GDP Expenditure Perspective: GDP  Consumption  Gross Private Investment  Government Purchases  Net Exports

26. Llad Phillips26 Review Part II: Chapter Three Conceptual Framework: Circular Flow Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective

27. Llad Phillips27 Expenditure Perspective: Open Firms Households Supply Goods Demand Goods Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Government: Purchase of Goods and Services All Three: Exports - Imports = Net Exports Imports (puchases) Exports (Sales) Government

28. Llad Phillips28 21: Behind the Economic Statistics Is a recession coming? Is a recession coming?  how would you figure that out?

29. Llad Phillips29 21: Behind the Economic Statistics Expenditure Perspective: GDP Expenditure Perspective: GDP  Consumption  Gross Private Investment  Government Purchases  Net Exports Inflation Inflation  what is it?  how do we measure it?  why is it a problem?

30. Llad Phillips30 Source: Yardeni’s Economics Network, http://www.yardeni.com/

31. Llad Phillips31 21: Behind the Economic Statistics Expenditure Perspective: GDP Expenditure Perspective: GDP  Consumption  Gross Private Investment  Government Purchases  Net Exports Inflation Inflation  what is it?  how do we measure it?  why is it a problem? Unemployment Unemployment

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33. Llad Phillips33 24: Coordinating Economic Activity If nominal GDP grows faster than real GDP, what happens? If nominal GDP grows faster than real GDP, what happens? If real GDP stops growing or declines, what happens? If real GDP stops growing or declines, what happens?

34. Llad Phillips34 25: Keynesian Economics and Fiscal Policy The Keynesian Cross The Keynesian Cross The Basic Ideas The Basic Ideas  GDP = National Income (equilibrium)  equilibrium GDP can differ from full employment GDP What Should We Do IF We Slip Into Depression? What Should We Do IF We Slip Into Depression?

35. Llad Phillips35 Consumption, C Investment, I GDP Income, Y Less than Full Employment Equilibrium C = C 0 + mpc* Y I GDP = C + I 45 0 GDP = Y Y FE Full Employment Income

36. Llad Phillips36 27: Money, the Banking System and the Federal Reserve What is money? What is money? Why are banking systems unstable? Why are banking systems unstable? Why do we need a central bank? Why do we need a central bank? What is monetary policy? What is monetary policy?  goals  objectives  tools

37. Llad Phillips37 The Functions of Money medium of exchange medium of exchange  instead of barter, i.e. exchange of goods & services for goods and services, we can exchange goods & services for money and vice versa  eliminates the search costs & inconvenience of barter store of value store of value  we can hold money as an asset  because it is a medium of exchange, it is liquid, i.e. we can convert money into goods & assets quickly unit of account unit of account  measure of value, “ a dollar’s worth of...”

38. Llad Phillips38 Definitions of Money M1(a measure of media of exchange) = M1(a measure of media of exchange) =  currency held by the public, outside of banks  checkable deposits  demand deposits  NOW (negotiable order of withdrawal) accounts savings & loans, mutual savings bankssavings & loans, mutual savings banks  traveler’s checks M2 = M1 + M2 = M1 +  money market accounts at banks  money market mutual fund accounts  certificates of deposit, CD’s, less than $100,000 M3 = M2 + CD’s over $100,000 M3 = M2 + CD’s over $100,000