Ngân hàng, tín dụng - Chapter 21: Monetary policy strategy

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 21 Monetary Policy Strategy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-2 Learning Objectives • Realize how the Federal Open Market Committee chooses an economic target and a policy lever to reach that target • Understand the mechanics of the federal funds market and how the Federal Reserve can interact in that market • Define the Taylor rule and explain its significance to monetary policy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-3 Introduction • “Federal Open Market Committee (FOMC) seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output” • Examination of the formulation of policy through the Federal Open Market Committee’s directive • Review the reasons for the particular course of action that is followed 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-4 The FOMC Directive • The FMOC meets every five or six weeks – Review of recent economic and financial developments • Prices • Unemployment • Interest rates • Money supply • Balance of payments • Bank credit – Makes projections for the future – Based on anticipated economic conditions, proposes appropriate monetary policy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-5 The FOMC Directive (Cont.) • The FOMC directive – In recent years, FOMC directive usually contains a single paragraph that begins with a general qualitative statement of current policy goals – Specifies the immediate prescription for implementing longer-term objectives – In outlining its operating targets, the Committee refers to conditions in the reserve markets, not in terms of money supply growth Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-6 The FOMC Directive (Cont.) • The FOMC directive (Cont.) – Although Fed emphasizes monetary and reserve aggregates, in practice it operates on interest rates (Federal Funds Rate) – After each meeting, the FOMC releases a statement • Summarizes the directive • Gives some idea of the Fed’s view of future policy risks • Indicates whether policy risks are mainly weighted toward inflationary pressure, economic weakness, or weighted equally between the two 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-7 The Fed’s Strategy • Humphrey-Hawkins Act of 1978 – Provides policy guidelines to Federal Reserve • Maximum employment • Price stability • Moderate long-term interest rates – Fed has interpreted maximum employment as full employment--economy functions at its potential – Meet these three goals by seeking price stability and sustainable growth since long-term interest rates are low when expected inflation is low Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-8 The Fed’s Strategy (Cont.) • Figure 21.1 summarizes some of the choices the Fed must make when deciding upon its strategy • Ultimate goals are two steps removed from the Fed’s tools • Operating and intermediate targets are more responsive to Fed’s actions • These two steps provide timely feedback so Fed can judge if their actions are on the right track Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-9 FIGURE 21.1 The Fed’s game plan. 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-10 The Fed’s Strategy (Cont.) • Steps in development of the Fed’s plan – Decide upon GDP growth rate consistent with inflation and unemployment objectives – Set range for monetary growth expected to generate target GDP growth – Set a target for growth in reserves • Key to the success of Fed’s effectiveness is understanding and predicting the linkages between the different steps Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-11 Reserves Versus the Federal Funds Rate • Different targets selected by Federal Reserve – Before October 1979—favored federal funds rate – October 1979 to mid-1982—shifted to reserve aggregates to get control over inflation – After mid-1982—shifted focus back to federal funds rate • It seems that reserves and the federal funds rate are two sides of the same coin Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-12 Reserves Versus the Federal Funds Rate (Cont.) • However, there is often an irreconcilable conflict that prevents the Fed from simultaneously targeting reserves and the fed funds rate • Characteristics of the federal funds market – Immediately available funds that are lent between banks, usually on an overnight basis – Transfer of funds through bookkeeping entry on reserves held by the Fed – Interest rate charged is the Federal Funds Rate 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-13 Reserves Versus the Federal Funds Rate (Cont.) • Figure 21.2 and Figure 21.3 – The Federal Funds Rate is established in the competitive market (supply and demand of reserves), but is influenced by the Fed (proactive action) • Increase reserves—Lower the rate • Decrease reserves—Raise the rate Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-14 FIGURE 21.2 The supply and demand for reserves produces the equilibrium federal fund rate. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-15 FIGURE 21.3 An increased supply of reserves lowers the federal funds rate; a lower federal funds rate requires an increased supply of reserves. 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-16 Reserves Versus the Federal Funds Rate (Cont.) • Figure 21.4 – In the real world, demand curves for reserves fluctuates with the pace of economic activity – These shifts in the demand curve will complicate the actions of the Fed (reactive action) – The Fed can target either the level of reserves or the federal funds rate • Targeting reserves—the federal funds rate will vary • Targeting federal funds rate—the level of reserves will vary Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-17 FIGURE 21.4 Controlling reserves (panel (a)) implies volatility in the federal funds rate, while controlling the federal funds rate (panel (b)) implies volatility in reserves supplied. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-18 FIGURE 21.4 Controlling reserves (panel (a)) implies volatility in the federal funds rate, while controlling the federal funds rate (panel (b)) implies volatility in reserves supplied. (Cont.) 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-19 Reserves Versus the Federal Funds Rate (Cont.) • The Fed cannot set reserve levels and the federal funds rate independently • Which target should the Fed choose? – Select one that produces less variability in GDP – Targeting reserves and letting interest rate change would be best under some conditions • Close and predictable relationship between reserves and spending • Private spending is subject to destabilizing variations • Resulting interest rate changes would stabilize the economy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-20 Reserves Versus the Federal Funds Rate (Cont.) • Which target should the Fed choose? (Cont.) – Targeting interest rates, with fluctuating reserves • Weak linkage between reserves and spending results in variation in demand for reserves not related to changes in spending • In this case, automatic changes in interest rates would not allow the Fed to stabilize the economy • Under these conditions, the Fed has concluded it is better to target the federal funds rate • With significant change in economic activity, it might be necessary to alter targeted federal funds rate Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-21 The Taylor Rule and Fed’s Track Record • During recent years, the Fed’s focus has clearly been on the use of the federal funds rate to influence interest rates • Interest rates then affect the aggregate demand for goods/services, the real GDP and the inflation rate • Although it is difficult to forecast the behavior of the Fed, it appears the general direction of interest rate policy can be explained by the Taylor rule 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-22 The Taylor Rule and Fed’s Track Record (Cont.) • Taylor rule – Federal funds rate target is a function of: • The difference between actual inflate rate (INFL) and the target inflation (INFL*) • The percentage difference between actual and potential real GDP (GAP) Federal funds rate = 2.5 + INFL + 0.5 (INFL - INFL*) + 0.5 GAP× × Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-23 The Taylor Rule and Fed’s Track Record (Cont.) • Figure 21.5 shows the actual fed funds rate and the rate implied by the Taylor rule – The fed funds rate seems to have responded quite well to the concerns of the Fed since it moves in the directions suggested by the Taylor rule – However, the actual fed funds rates doesn’t always follow the Taylor rule • Impossible to react to certain events such as September 11 until they influence economic activity • Suggests an argument for giving the Fed some discretion in responding to special circumstances Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 21-24 FIGURE 21.5 The Actual fed funds rate and the value implied by the Taylor rule.