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Limitations of Monetary Policy

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

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Limitations of Monetary Policy

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  1. Limitations of Monetary Policy

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

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

  4. 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

  5. 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of consumer goods and reduction in supplyallowed businesses to focus on production of war goods • ability to do this was revoked in 1952

  6. 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.

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

  8. 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)

  9. 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

  10. 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)

  11. 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

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