Presentation Transcript
Monetary Policy: Monetary Policy Effects on:
Money Supply
Bond Prices
Interest Rates
Exchange Rates
Exports and Imports
Aggregate Demand
Recession or Less than Full-Employment What can the Federal Reserve do?: Recession or Less than Full-Employment What can the Federal Reserve do? Buy Bonds (Securities) –Most likely
Lower the Reserve Requirement
Lower the Discount Rate
Buying bonds (securities), lowering the Reserve Requirement or lowering the Discount Rate, will put more money into the banking system. Supply of funds available in the banking system will INCREASE!!: Buying bonds (securities), lowering the Reserve Requirement or lowering the Discount Rate, will put more money into the banking system. Supply of funds available in the banking system will INCREASE!! Nominal
Interest
Rate Money Supply I* Qm* Qm1 I1 MS* MS1 DM* The Federal Reserve
Controls the Money
Supply, which determines the Nominal Interest Rate in the Short-Term Money Markets
Slide4: Quantity of Bonds Supply of
Bonds Pb* Qb* The Bond (Securities) Market Demand for Bonds Price of Bonds When the Fed buys bonds, they take bonds out of the Bond Market. This Decreases the Supply of Bonds. The Price of Bonds varies INVERSELY with Interest Rate. As the Price of Bonds go up, the Interest rate on the bonds goes down. Most interest rates charged to C, I and or G are link to bond prices. Qb1 Pb1 Sb1
The Fed Buying bonds (securities), lowering the Reserve Requirement or lowering the Discount Rate, will increase the money available to the banking system . The Supply of funds to be loaned out will INCREASE!! (The Market for Loanable Funds establishes the REAL Interest Rates (Long-Term Rates). : The Fed Buying bonds (securities), lowering the Reserve Requirement or lowering the Discount Rate, will increase the money available to the banking system . The Supply of funds to be loaned out will INCREASE!! (The Market for Loanable Funds establishes the REAL Interest Rates (Long-Term Rates). Real
Interest
Rate Market for Loanable Funds I* Demand for Loanable Funds Qm* Supply of Loanable Funds SLF 1 I 1 Qm1
AggregateDemand/Aggregate Supply Less than Full-Employment/Recession: AggregateDemand/Aggregate Supply Less than Full-Employment/Recession Price
Level Gross Domestic Product (Fe)
Y(f) (AS) P1 (AD) P* Y* AD1 At Y* the economy is at less than full-employment. With the increase in the Money Supply
the interest rate decreases. This prompts consumers (C), businesses (I) and Government (G), to borrow more money. This money will be spent on Goods and Services somewhere in the economy. Consumption, Investment and possibly Government spending will increase. The value of the dollar will decrease (depreciate). Exports will increase. This will cause the Aggregate Demand curve to shift to the right toward Full-employment. This is called EXPANSIONARY (Loose) monetary policy.
C I G therefore AD and unemployment
Inflation What can the Federal Reserve do?: Inflation What can the Federal Reserve do? Sell Bonds (Securities) –Most likely
Raise the Reserve Requirement
Raise the Discount Rate
Selling bonds (securities), Raising the Reserve Requirement or Raising the Discount Rate, will take money out of the banking system. Supply of funds available in the banking system will DECREASE!!: Selling bonds (securities), Raising the Reserve Requirement or Raising the Discount Rate, will take money out of the banking system. Supply of funds available in the banking system will DECREASE!! Interest
Rate Money Supply I* Qm* Qm1 I1 MS* MS1 DM* The Federal Reserve
Controls the Money
Supply, which determines
The Interest Rate
Slide9: Quantity of Bonds Supply of
Bonds Pb* Qb* The Bond (Securities) Market Demand for Bonds Price of Bonds When the Fed sells bonds, they put bonds into the Bond Market. This Increases the Supply of Bonds. The Price of Bonds varies INVERSELY with Interest Rate. As the Price of Bonds go down, the Interest rate on the bonds goes up. Most interest rates charged to C, I and or G are link to bond prices. Qb1 Pb1 Sb1
The Fed selling bonds (securities), Raising the Reserve Requirement or Raising the Discount Rate, will decrease the money available to the banking system . The Supply of funds to be loaned out will DECREASE!!: The Fed selling bonds (securities), Raising the Reserve Requirement or Raising the Discount Rate, will decrease the money available to the banking system . The Supply of funds to be loaned out will DECREASE!! Interest
Rate Market for Loanable Funds I* Demand for Loanable Funds Qm* Supply of Loanable Funds I 1 Qm1 SLF1
AggregateDemand/Aggregate Supply Presence of INFLATION: AggregateDemand/Aggregate Supply Presence of INFLATION Price
Level Gross Domestic Product (Fe)
Y(f) (AS) P1 (AD) P* Y* AD1 At Y* the economy is experiencing INFLATION. With the decrease in the Money Supply
the interest rate INCREASES. This prompts consumers (C), businesses (I) and Government (G), to borrow LESS money. The value of the dollar will increase (appreciate). Imports will increase. This will cause the Aggregate Demand curve to shift DOWN toward Full-employment. This is called CONTRACTIONARY (TIGHT) monetary policy
C I G therefore AD and unemployment
Interest Rate effect on the Exchange Rate: Interest Rate effect on the Exchange Rate Suppose the Interest Rate in U.S. is HIGHER relative to the Interest Rate in the Rest of the World.
Foreigners will want to invest in the U.S because they can get a higher interest rate. U.S Financial Assets will be more desirable. To do this they will need U.S. dollars.
Supply of the Foreign Currency in the currency market will INCREASE as Foreigners give up their currency and increase their DEMAND for U.S. Dollars.
Slide13: Market for Euros Dollar Price
Per Euro $* €* Demand for Euros Supply of Euros Exchange
Rate Quantity of Euros $1 €1 S€1
Slide14: Quantity of Dollars
Exchange
Rate Market for Dollars Euro Price
Per Dollar €* $* Demand for Dollars Supply of Dollars €1 $1 D$1
What is the effect on the Exchange Rate?: What is the effect on the Exchange Rate? The Dollar price per Euro decreases (it becomes cheaper for us to buy) and the Euro Price per Dollar increases (it becomes more expensive for Europeans to buy dollars)
The Dollar has APPRECIATED in value relative to the foreign currency.
We can purchase more goods from the Europeans because the dollar buys more of their currency.
What effect does the exchange rate between currencies have on Exports and/or Imports?: What effect does the exchange rate between currencies have on Exports and/or Imports? If the price of a dollar RISES relative to a foreign currency then it is said that the Dollar has APPRECIATED (gotten stronger) in value.
The dollar can now purchase more of the foreign currency than it could before. Foreign goods are now less expensive because our dollars can purchase more of their goods. On the other hand, foreign currencies have DEPRECIATED in value relative to the dollar so our currency is more expensive to buy and our goods become relatively more expensive for foreigners to buy.
IMPORTS WILL INCREASE AND EXPORTS WILL DECREASE WHEN THE DOLLAR DEPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES
Interest Rate effect on the Exchange Rate: Interest Rate effect on the Exchange Rate Suppose the Interest Rate in U.S. is LOWER relative to the Interest Rate in the Rest of the World.
Americans will want to invest in the country paying a higher interest rate. Financial Assets elsewhere will be more desirable. To do this they will need the foreign currency.
Supply of U.S. Dollars in the currency market will INCREASE as Americans give up dollars and increase their DEMAND for the foreign currency.
Slide18: Quantity of Dollars
Exchange
Rate €1 $1 S$1
Slide19: Market for Euros Dollar Price
Per Euro $* €* Demand for Euros Supply of Euros Exchange
Rate Quantity of Euros $1 €1 D€1
What is the effect on the Exchange Rate?: What is the effect on the Exchange Rate? The Dollar price per Euro increases (it becomes more expensive for us to buy) and the Euro Price per Dollar decreases (it becomes less expensive for Europeans to buy dollars)
The Dollar has DEPRECIATED in value relative to the foreign currency.
We can purchase fewer goods from the Europeans because the dollar buys less of their currency.
What effect does the exchange rate between currencies have on Exports and/or Imports? : What effect does the exchange rate between currencies have on Exports and/or Imports? If the price of a dollar is LOWER relative to a foreign currency then it is said that the Dollar has DEPRECIATED (gotten weaker) in value.
The dollar can now purchase less of the foreign currency than it could before. Foreign goods are now more expensive because our dollars can purchase less of their goods. On the other hand, foreign currencies have APPRECIATED in value relative to the dollar so our currency is less expensive to buy and our goods become relatively cheaper for foreigners to buy.
IMPORTS WILL DECREASE AND EXPORTS WILL INCREASE WHEN THE DOLLAR DEPRECIATES IN VALUE RELATIVE TO OTHER CURRENCIES