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Federal Reserve Monetary Policy and the IEM

Federal Reserve Monetary Policy and the IEM. Background and Introduction. Creation of the Federal Reserve System Policies of the Federal Reserve System Employment Act of 1946 Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 Other Policy Guidelines of the Fed

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Federal Reserve Monetary Policy and the IEM

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  1. Federal Reserve Monetary Policy and the IEM

  2. Background and Introduction Creation of the Federal Reserve System Policies of the Federal Reserve System Employment Act of 1946 Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 Other Policy Guidelines of the Fed Natural Rate of Unemployment Moderate Inflation Rate

  3. Employment Act of 1946 • This act directed policymakers to pursue policies to achieve full employment and noninflationary growth

  4. Humphrey-Hawkins Full Employment & Balanced Growth Act of 1978 • This act required that policymakers pursue policies to achieve full employment and noninflationary economic growth

  5. Natural Rate of Unemployment • An unemployment rate which excludes cyclical unemployment but includes frictional and structural unemployment (believed to be about 4.5 percent)

  6. Moderate Inflation • Many economists consider a rate of inflation of about one to two percent moderate and bearable, even though some may prefer no inflation.

  7. Macroeconomic Policy Goals • Full Employment • Stable Prices • Satisfactory Balance of Payments • Sustainable Economic Growth

  8. Short Run Goals: Achieving these goals helps in achieving the long run goal Full Employment Satisfactory External Balance compatible with full employment and stable prices Stable Prices Long Run Goal: Sustainable economic growth determined by the growth and productivity of labor and capital

  9. Three Tools of Monetary Policy 1. Reserve Requirement • About 5 to 10% of transactions accounts • Non-interest bearing • Seldom changed • Set by Board of Governors

  10. Three Tools of Monetary Policy 2. Discount Rate • Interest rate • Short-term (overnight) loans • Set by Federal Reserve Banks / approved Board of Governors • Signal to markets

  11. Three Tools of Monetary Policy 3. Open Market Operations • FOMC directive • Affects Fed funds rate • Purchase / sell Treasury securities • Federal Reserve / securities dealers • Implemented at Federal Reserve Bank of New York

  12. Federal Open Market Committee (FOMC) • Board of Governors • Presidents of Reserve Banks • Five presidents vote • New York Federal Reserve    Bank president always votes • Remaining presidents alternate   voting membership

  13. Concepts • Inflation • Deflation • Stagflation • Cost-Push Inflation • Demand-Pull Inflation • Stop-Go Policy Cycle

  14. Inflation • A significant and persistent increase in the price level.

  15. Deflation • A drop in the overall price level

  16. Stagflation • A condition of concurrent high unemployment (stagnation) and inflation

  17. Cost-Push Inflation • An inflation triggered by increases in input prices

  18. Demand-Pull Inflation • An inflation caused by high levels of demand

  19. Stop-Go Policy Cycle • Alternating implementation of expansionary and contractionary policies to deal with downturn and upturn in economic activities

  20. Aggregate Demand • The total quantity of commodities that are demanded at various prices

  21. Aggregate Supply • The total quantity of commodities that are supplied at various prices

  22. Aggregate Demand and Aggregate Supply Curves ( Short-Run & Long-Run) Price Level LRAS SRAS AD Real GDP

  23. Long-Run Aggregate Supply Curve • The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level. (full employment is assumed)

  24. Steady Noninflationary Growth B LRAS LRAS’ Price Level • D 1.06 A 1.00 AD' AD $5,000 $5,200 Real GDP (billions)

  25. Increase in price level due to increase in aggregate demand with no Fed response Price Level LRAS SRAS' C SRAS 1.12 B 1.06 1.00 A AD' AD $2,000 $2,400 Real GDP (billions)

  26. Demand Fall-Induced Recession Price Level LRAS SRAS SRAS' A 1.00 B .96 .92 C AD' Real GDP (in billions)

  27. Phillips Curve • A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

  28. The Phillips Curve O

  29. Supply Shock • A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

  30. An Adverse Supply Shock as a Cause of Cost-Push Inflation LRAS SRAS' Price Level SRAS C B A AD' AD Real GDP

  31. Accommodating Policy • Policymakers’ action to increase aggregate demand in response to a negative supply shock

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