1. The Conduct of Monetary Policy zThe specific “nuts and bolts” of monetary policy, from beginning (policy tools) to end (key macroeconomic variables such as the price level and real GDP).

2. How Monetary Policy is Done -- A Diagram Policy Tools  Operating Target  Intermediate Target  Final Targets

3. Important Terms zPolicy Tools -- The Federal Reserve’s policy instruments, usually open market operations (OMOs). zFinal Targets -- Overall goal variables for the economy, such as real GDP (Y) or the price level (P).

4. Intermediate Targets zIntermediate Targets -- Variables which are known to have a direct effect on final targets. zPossible Candidates – an interest rate (short-term and long-term), M1, M2, other money supply measures.

5. Operating Targets zOperating Targets -- Variables which are known to have a direct effect on intermediate targets. zPossible Candidates -- the Federal Funds rate (i FF ), Reserves (R), the Monetary Base (H), the Nonborrowed Base (H NON ), Nonborrowed Reserves (R NON ).

6. Criteria for Choosing Intermediate Targets zMeasurability -- The variable must be accurately measured and available on a frequent basis. zControllability -- The Fed should be able to hit the target with reasonable accuracy on a consistent basis.

7. zPredictive Accuracy -- Given the value of the intermediate target, the Fed should be able to predict with reasonable accuracy the final targets. zThe Money Supply -- not great at controllability, stronger on predictive accuracy.

8. Criteria for Choosing Operating Targets zSame as choosing intermediate targets. zControllability more important. zPredictive ability -- applies to intermediate target.

9. The Current Conduct of US Monetary Policy Policy Tools  Operating Target  Intermediate Target  Final Targets Since 1988: OMOs  i FF  M2  Y, P

10. Setting Monetary Policy -- Expansionary zThe FOMC lowers the target Federal Funds Rate. zTo achieve this target, the Open Market Manager buys bonds, supplying more reserves to the system. zThe Fed does this until the new equilibrium i FF equals its newly set target rate.

11. Setting Monetary Policy -- Contractionary zThe FOMC raises the target Federal Funds Rate. zTo achieve the FOMC’s new target, the Open Market Manager sells bonds, thereby removing reserves from the system. zThe Fed does this until the equilibrium i FF equals its target.

12. Maintaining Monetary Policy (Increased Loan Demand) zIncome (Y) or Loan Demand increases. zThis change increases the Demand for Reserves, shifting the curve rightward, and threatening to increase the equilibrium i FF. zThe Open Market Manager increases the Supply of Reserves until the equilibrium i FF equals its mandated target rate.

13. The Procyclical Money Supply zOutcome of Federal Funds rate targeting, due to policy maintenance. zMoney supply misses its target in the direction of the business cycle (e.g. too much during inflation). zPotentially destabilizing on economy, money supply miss aggravates the existing macro problem.

14. Monetary Policy -- Current Issues and Developments zM1 is becoming obsolete -- sweep programs. zLess reliance on money supply for short-term policy, used for longer-term growth targets instead. zGreater reliance on i FF as an operating target. Has it in fact become the intermediate target?

15. More Developments zThe end of stand-alone investment banks? (merging with banks or converting into banks) zThe restructuring of Fannie Mae and Freddie Mac zAnother look at mortgages and mortgage securitization

16. Developments -- Banking zGetting out of the mortgage foreclosure problem and stabilizing the banking system. zHarsher bank regulations coming down (as with FIRREA)? zMore global cooperation and coordination of banking and financial market regulations? zContinuous Financial innovation -- a given.