Lecture 32: Monetary policy goals, strategy and tactics – part two

1. Lecture 32: Monetary policy goals, strategy and tactics – part two Mishkin Ch16 – part B page 412-419

2. Introduction • Monetary goal • Monetary strategies • Monetary tactics – policy instruments • Monetary policy tools

3. Three monetary policy tools • Open market operation • Reserve requirements • Discount policy (discount rate)

4. Two policy instruments • Policy instruments (operating instruments): A variable that responds to the central bank’s tools and indicates the stance (loose or tight) of monetary policy • Two policy instruments: • Reserve aggregates: R, MBn, MB, • Interest rates: short-term interest rate • Interest-rate and aggregate targets are incompatible. • May be linked to an intermediate target: M2, long-term interest rate, which are more closely related to goals.

7. Criteria for choosing the policy instrument • Observability and measurability • time lag in measuring reserves • hard to measure real interest rate • Controllability • better control over nominal interest rates than over reserves • Predictable effect on goals • Interest rates link more closely to goals

8. The Taylor rule • Inflation target 2%, output potential, equilibrium real fed funds rate 2% • An inflation gap and an output gap • Stabilizing real output is an important concern • Output gap is an indicator of future inflation as shown by Phillips curve