Module Monetary Policy and the Interest Rate

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ModuleMonetaryPolicy and the Interest Rate
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• KRUGMAN'S
• MACROECONOMICS for AP

Margaret Ray and David Anderson
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What you will learnin this Module

• How the Federal Reserve implements monetary
  policy, moving the interest rate to affect
  aggregate output
• Why monetary policy is the main tool for
  stabilizing the economy

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Jim Cramers Pleas to Ben Bernanke
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The Fed Reverses Course
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Monetary Policy and the Interest Rate Targeting
the Fed Funds Rate
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Expansionary Monetary Policy
The Economy
The Money Market
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Contractionary Monetary Policy
The Money Market
The Economy
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Fed Policy and the Output Gap

• The Federal Reserve engages in expansionary
  monetary policy (they lower the interest rate)
  when the output gap (the difference between
  potential RGDP and actual GDP) becomes negative.
• The Federal Reserve engages in contractionary
  monetary policy (they raise the interest rate)
  when the output gap becomes positive.

Stanford Economist, John Taylor
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Fed Policy and the Inflation Rate

• The Federal Reserve engages in expansionary
  monetary policy (they lower the interest rate)
  when the inflation rate falls.
• The Federal Reserve engages in contractionary
  monetary policy (they raise the interest rate)
  when the inflation rate rises.

Stanford Economist, John Taylor
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Monetary Policy in Practice

• Stanford economist John Taylor proposes that the
  Fed follow a rule
• Fed Funds ...
• 1(1.5 X p)(0.5 X Output Gap)
• (p) represents the inflation rate

Stanford Economist, John Taylor
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Monetary Policy in Practice

• In practice it appears that the Fed does follow
  the Taylor rule.
• The Taylor rule reflects more closely what the
  Fed actually does with the Federal Funds rate

Stanford Economist, John Taylor
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Inflation Targeting

• The Fed tries to keep inflation low but positive
• The Fed does not explicitly commit itself to a
  particular rate of inflation
• Inflation Targeting (setting a target inflation
  rate or range) is the policy of other countries
  central banks
• Pros of inflation targeting argue that it makes
  Fed policy more transparent and keeps the Fed
  accountable
• Opponents argue that it limits the Fed to dealing
  only with inflation when there may be other
  concerns