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ECON 2010 Prin Macroeconomics Chapter 15 Notes

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Louisiana State University
ECON 2010

1Chapter 15 Monetary PolicyIWhat is Monetary PolicyaMonetary policystrategyactions the Federal Reserve takes to manage the money supplyinterest rates for pursuing certain economic objectivesbGoals of monetary policy 4 goals intended to promote a wellfunctioning economyiPrice stabilityiiEconomic growthstability encouraging long run invetmentsiiiHigh employmentivStability of financial marketsinstitutionscThe Fed chairmangovernors are not elected but appointed by the presidentconfirmed by the Senate for staggered terms not coinciding with electionsThey are not members of an administrationdThus the Fed is largely insulated from political pressuresChairmen are however subject to being reappointed every four yearsprotecting their own reputationeThe Fed looks after the longterm interests of the nations economyfinancial systemfPrice stability following the great inflationary spike of the 70s into early 80s the Fed maintains an antiinflation biasHigh amongst its goals is containing inflationiFed promotes the stability of financial marketsinstitutions so that an efficient flow of funds from savers to borrowers will occuriiInvestment banks can be subject to liquidity problems because they often borrow short term invest funds in long term investmentsThey borrow from other banksiiiCommercial banks borrow from householdsgIf inflation is low over the long run the Fed will have the flexibility it needs to lesser the impact of recessionhHigh employmentunemployed workersunderused factories reduce GDP below its potential levelIIThe Goals of Monetary PolicyaEconomic GrowthiPolicymakers aim to encourage stable economic growth allowing householdsfirms to effectively trust the economyencouraging longrun investment needed to sustain growth2iiIn the US this translates to an ideal GDP growth rate of 3 to 4 annuallyiiiGrowth levels must provide increasing living standardscomfortable employment levelsbHigh EmploymentiThe labor market produces the most political pressureThe Fed along with other agencies concerned with the economy are keen to ensure the economy allows for low levels of unemploymentsolid wagescStability of Financial MarketsInstitutionsiThe Fed works with other agencies to ensure longterm viabilitysecurityIt will intervene against market bubbles select major institutional failuresother events representing serious consequences to the bankingfinancial industryiiThere are always critics who applaud or deride Fed actionsRegardless the Fed can exercise enormous power if it so choosesdThe 2 main monetary policy targets are the money supplyinflationeDemand curve for money is downward sloping householdsfirms can hold money or hold other financial assetsMoney is desired to buy thingsMoney is undesirable in a way that it earns little or no interestWhen interest rates rise on financial assets the amount of interest that householdsfirms lose by holding money increases the opportunity cost increases so the quantity of money demanded will be lowvisa versafChanges in variables other than price causes the demand curve to shiftThe demand curve for money is drawn holding constant all variables other than interest ratesgReal GDPthe price level are the most important variables that cause the demand curve to shiftiIncrease in GDPmore buyingsellingincreases demand for money right shiftiiA higher price level increases quantity of money required to buysell shift rightIIIThe Money Marketof Monetary Policy TargetsaMonetary Policy TargetsiThe Fed tries to keep both the unemploymentinflation rate low but it cant affect either of these economic variables directlyiiThe Fed uses variables called monetary policy targets which it can affect directlyin turn affect variables such as real GDP employmentthe price level closely related to the Feds policy goals
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