Monetary Theory and Policy
How Monetary Policy Affects Economy
Lags in Monetary Policy
n Recognition lag
l Most economic problems revealed by statistics, not observation
l Fed quick to see changes in economy
n Implementation lag
l Fed acts quickly to implement change in monetary policy
l Fiscal policy via Congress takes a long time
n Impact Lag
l Takes time for monetary changes to have full impact
l Fiscal policy tax changes have unpredictable results
Tradeoff of Monetary Policy Goals
n Goals of the Monetary Policy
l Steady GDP growth
l Low unemployment
l Stable price levels
n Tradeoffs
l Lowering unemployment by stimulating the economy may increase inflation
l Lowering inflation by slowing the economy may increase unemployment
Assessing the Impact of Monetary Policy
n How does the policy change affect financial market participants?
l Depends on the kinds of securities you trade
u Value of bonds inversely related to interest rates
u Value of stocks depends on expectations about how the changes affect on the economy
u Value of foreign currencies inversely related to interest rates
Assessing the Impact of Monetary Policy
n Financial market participants look at actual growth compared to Fed targets
l Hires economists to assess impact on portfolios
l Even if changes in the money supply are correctly anticipated, there are still problems
u Not a stable relationship between money supply and economic variables over time
Integrating Monetary and Fiscal Policies
n Combined monetary and fiscal policy effects
l Fiscal policy usually has a larger influence on the demand for loanable funds
l Monetary policy usually has a larger influence on the supply of loanable funds
n “Monetizing” the debt
l The Fed help finance a federal budget deficit created by fiscal policy
Global Effects on Monetary Policy
n Impact of the U.S. dollar
l Value of the dollar relative to other currencies can affect inflation
l A weak dollar stimulates U.S. exports, discourages imports and stimulates the economy
l A strong dollar stimulates imports and economic growth, and encourages capital flows into U.S. and lower interest rates
Global Effects on Monetary Policy
n Transmission of interest rates
l International flow of funds affected by Fed policy, and vice versa
l Budget deficits or surpluses in the U.S. have global implications
u “Global crowding out”
u That’s why other countries can be very concerned with USA’s deficit!