Monetary Theory and Policy.ppt

1、5,Monetary Theory and Policy,Chapter Objectives,Learn the well-known theories of monetary policy Review the tradeoffs involved in monetary policy Learn how analysts monitor and forecast Feds monetary policy,1. Monetary Policies,How does money affect the real economy? How does varying money supply gr

2、owth impact spending? How does monetary policy in the financial sector impact real economic sector investment and spending?,1.1 Keynesian Theory,Developed by John Maynard Keynes and his students Initially attempted to explain inadequacy of monetary policy during Great Depression Effectiveness of mon

3、etary policy depends upon the sensitivity (elasticity) of economy to changes in interest rates,Keynesian Theory, cont.,Advocates fiscal policy Focused on government deficit/surplus spending to impact economic activity Monetary policy transmitted slowly via bank credit policy and interest rates A pro

4、active economic policy Correcting economic recession and high inflation,Exhibit 5.3,a,a,$,$,Effects of a Credit Crunch,An economic condition where investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations, thereby driving up the price of debt product

5、s for borrowers. Credit crunches are usually considered to be an extension of recessions. A credit crunch makes it nearly impossible for companies to borrow because lenders are scaredof bankruptcies or defaults, which results in higher rates. The consequence is a prolonged recession (or slower recov

6、ery), which occurs as a result of the shrinking credit supply.,Effects of a Credit Crunch,A credit crunch may partially offset the desired effects of a simulative monetary policy (need more sufficient qualified borrowers) and magnify the effects of a restrictive monetary policy (prevent potential bo

7、rrowers from obtain loans),1.2 Monetary Theories,Quantity theory (Milton Friedman) Based on equation of exchange MV = PGQ M =amount of money in the economy V =velocity, average number of times each dollar changes hands during the year PG =weighted average price level of goods and services in the eco

8、nomy Q =quantity of goods and services sold,Monetary Theories,Quantity theorys assumptions PGQ is the total value of goods and services produced Assume V constant or predictablechanging M impacts total spending M should grow at rate of output capacity, Q Faster M growth increases PG or inflation,Mon

9、etary Theories,Monetarists Velocity is affected by Income levels Frequency income is received Use of credit cards Inflationary expectations Velocity changes found to be predictable and not related to fluctuations in money supply,Monetarist vs. Keynesian Theories,Monetarist Let economic problems reso

10、lve themselves Low growth reduces borrowing and lowers interest rates Problem: It takes time (too passive),Keynesian Need to take action to lower interest rates High money growth to fix a recession by lowering rates Problem: Might ignite inflation,Monetarist vs. Keynesian Theories,Monetarist Low, st

11、able growth in the money supply Focus on maintaining low inflation and will tolerate what they call natural unemployment Without causing additional problems,Keynesian Actively manage the money supply Willing to tolerate inflation that helps reduce unemployment,1.3 Rational Expectations Theory,Househ

12、olds and businesses act in their own self-interest Individuals anticipate effects of government policy changes Expansionary monetary policy signals future inflation and interest rates increase (security prices fall) Rational expectations may nullify intended effects of monetary policy,2. Tradeoff of

13、 Monetary Policy Goals,Goals of the Monetary Policy Steady GDP growth Low unemployment Stable price levels Tradeoffs Lowering unemployment by stimulating the economy may increase inflation Lowering inflation by slowing the economy may increase unemployment Phillips Curve,Tradeoff of Monetary Policy

14、Goals,Fed determine whether unemployment or inflation is the more serious problem Higher inflation: tight-money policy-reduce economic growth-price and sales volume remain stable-workers are not in demand-inflation rate reduced and stagnant economy(sales decrease, inventories accumulate, reduce work

15、force)-high unemployment rate In fact, sometimes, neither tight-money policy nor loose-money policy could fully eliminate either problem (unskilled workers, oil prices high),Tradeoff of Monetary Policy Goals,Fed need decide which money policy should be selected under worse condition (both inflation

16、and unemployment are high)-see exhibit 5.5 Some outside factors have affected both the variables (oil price, close of training center)-see exhibit 5.6 Persian Gulf War,3.1 Economic Indicators Monitored by the Fed,Indicators of economic growth Gross Domestic Product or GDP (it measures the total valu

17、e of goods and services produced during a specific period) Industrial production National income (it is the total income earned by firms and individual employees during a specific period) Unemployment Many types of indexes,Economic Indicators Monitored by the Fed,Indicators of Inflation Producer pri

18、ce indexes (which represents prices at the wholesale level) Consumer price Indexes (which represents prices paid by consumers at retail level) Agricultural price indexes and housing price indexes Other indicators (wages rates, oil prices, transportation costs, gold price) Indicator of economic growt

19、h (Why does Fed could use these to indicate inflation?),Economic Indicators Monitored by the Fed,How the Fed uses indicators Fed meets to decide course of monetary policy Assesses recent reports on indicators of growth and inflation Uses indicators to anticipate how the economy will change Decides t

20、he appropriate monetary policy given possible conditions,3.2 Lags in Monetary Policy,Recognition lag (lag between the time a problem arises and the time it is recognized) Most economic problems revealed by statistics, not observation Implementation lag Fed acts quickly to implement change in monetar

21、y policy Fiscal policy via Congress takes a long time Impact Lag Takes time for monetary changes to have full impact Fiscal policy tax changes have unpredictable results,3.3 Assessing the Impact of Monetary Policy,How does the policy change affect financial market participants? Depends on the kinds

22、of securities you trade Depends on your expectations about how the changes affect on the economy Forecasting money supply movements Financial market participants look at actual growth compared to Fed targets Growth outside range could signal Fed policy changes,Assessing the Impact of Monetary Policy

23、,Improved communication at the Fed Fed more willing to disclose its intentions since 1999 Immediate feedback to public and financial markets about “bias” on rates Market reaction to reported money supply levels Thursday release of money supply data Try to determine future trends in interest rates,As

24、sessing the Impact of Monetary Policy,Anticipating reported money supply levels Securities and financial market professionals cannot profit on information available to all at the same time Try to forecast and anticipate changes Trying to figure out the future course of interest rates and Fed policy

25、Market reaction to discount rate adjustment,Assessing the Impact of Monetary Policy,Market reaction to discount rate adjustment Monitor changes to determine policy Some changes are technical or intended to bring the discount rate in line with market rates Financial market participants try to anticip

26、ate changes Discount rate seems to preceded market interest rate movements since 1980,Exhibit 5.9,a,Assessing the Impact of Monetary Policy,Forecasting the impact of monetary policy Even if financial market participants correctly anticipate changes in the money supply there are still problems Not a

27、stable relationship between money supply and economic variables over time Examples include the relationship between economic growth and the money supply,3.4 Integrating Monetary and Fiscal Policies,Relationship-influenced by fiscal policies (complementary and conflicting) History Executive branch us

28、ually most concerned with employment and growth Fed and administration may differ on priorities of price stability or growth needs Agreement when inflation and unemployment are at relatively low levels,Exhibit 5.12,a,Integrating Monetary and Fiscal Policies,Combined monetary and fiscal policy effect

29、s Fiscal policy usually has a larger influence on the demand for loanable funds Monetary policy usually has a larger influence on the supply of loanable funds See Exhibit 5.12,Integrating Monetary and Fiscal Policies,Monetizing the debt Definition-financing the national debt by printing new money or

30、 through open market operation, which cause inflation due to a large money supply Should the Fed help finance a federal budget deficit created by fiscal policy? Fed may prefer not to monetize the debt See Exhibit 5.13 (P130),Integrating Monetary and Fiscal Policies,Market assessment of integrated po

31、licies Financial markets assess both fiscal and monetary policy Markets monitor a wide range of information and data Forecast how loanable funds supply and demand will change See exhibit 5.14,3.5 Global Effects on Monetary Policy,Impact on the U.S. dollar Value of the dollar relative to other curren

32、cies can affect inflation A weak dollar stimulates U.S. exports, discourages imports and stimulates the economy Fed less likely to stimulate the economy if the dollar is weak Strong dollar Stimulates imports and dampens economic growth Fed is more likely to use stimulative policy,Global Effects on Monetary Policy,Transmission of interest rat