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Overview
Who
Expansionary
Contractionary
Easy $
Tight $
Benefits
Problems
3 Influences
Information

Monetary Policy Overview:
  Monetary Policy is the use of money availability and credit control to influence interest rates unemployment, and real GDP with three main methods: change the discount rate, reserve ratio, and buy and sell bonds(Government Securities) via the Federal Reserve.



The Federal Reserve:
   The Fed is the central bank of the United States established by congress in 1913 for the purpose of aiding the country's financial system. It now serves the purpose of: administrating monetary policies, protecting the credit of consumers, maintaining financial stability, and finally, providing financial services. The system is made up of 7 members of the Board of Governors and 12 banks located in major cities throughout the United States with the headquarters in Washington, D.C. The members are appointed by the President and approved by the Senate to serve 14 year terms. The President also designates who is Chairman and Vice Chairman of the board if they are approved by the Senate. Only one member can be selected from the any of the 12 Federal Reserve Districts and by law must be a fair representation of a sector of the public. The seven members of the Board of Governors makeup the majority of the 12 member Federal Open Market Committee or the FOMC. The other five members are reserve bank presidents of which the Vice Chairman must be that of the Federal Reserve Band of New York and the Chairman must be the same as the Chairman of the Board of Governers.



Expansionary Policy:
  Expansionary Policy is used to increase spending on goods and services or shift the AD curve rightward.

-> Here we see real money supply increasing causing lower interest rates but also decrease investment. Though the decrease in investment is a negative effect, however, it is likely the change in interest will reap strong enough benefits to make the action beneficial by counteracting the leftward shift(crouding out: see fiscal policy). If AD is intersecting the recessionary part of AS(the horizontal range), the expansionary policy could be used to bring the economy closer to full employment. The best example of this is F.D.R. getting the country out of the Great Depression and the war time economy soon after.

-> Lower interest rates from the above cause an increase in the quantity of investment demanded.

-> The change in I ultimately shifts both AE and AD right interpreting to an increase in Real GDP.

-> The change in I ultimately shifts both AE and AD right interpreting to an increase in Real GDP.



Contractionary Policy:
   The contractionary policy causes the opposite effects of the expansionary policy above. There may be a need to stop or prevent inflation in over-full-employment situations.

-> Here we can see that AD was past the physical limit(exaggerated for purpose of example). What the contractionary policy would do is try to push it to the intermediate level.





Easy Money Policy:
   A policy by which a central monetary authority, such as the Federal Reserve System, seeks to make money plentiful and available at low interest rates. If there's a period of slow growth the easy money policy will lower the interest rate=>decrease foreign demand for dollars=>dollar appretiates=>Exports increase.



Tight Money Policy:
   A policy by which a central monetary authority, such as the Federal Reserve System, seeks to make money less available by increasing interest rates. If there is inflation the tight money policy would increase the foreign demand for the dollar=>dollar appretiates, and Net exports would decrease.



Benefits of Monetary Policy:
   Obviously the main benefit of the monetary policy lies within the purpose it was created for, however it also can counteract possible political negative influence from an to-be implemented or already implemented policy. The economics of the country relies on a delicate cycle that is not yet fully understood though it is predictable to some degree.(People are predictable to some degree... I know how many people are likely to visit my site tomorrow using basic statistical inference. How could they say their decision to click the site was purely by choice? There would be far stronger variability...) Through the use of either Fiscal, Monetary, or Trade Policy extra security is placed to make sure any one of the influential variables keeping the cycle balanced stays between a stable interval.



Problems with Monetary Policy:
   There is no sure time to implement the Monetary Policy as a sure bet to help the economy. Economist must struggle and debate over what they believe are the best actions to improve the economic climate of the future. Could the economy fix itself? How is the Government Spending and its plans? There is two types of lag that must be addressed: how long will it take to see the effects of a policy and how reliable is the data the economist are working off of.(lag in statistical information compilation) Experimenting with economics is like playing the lottery with the country's money. There can be devastating effects such as high inflation and an overall left movement in the AD and AE curve in the longrun leaving the country worse off than it already was. Part of the problem is that there is no comprehensive theory to make fully confident decisions to influence the economy. There's just too many variables that can factor in that are sometimes unpredictable or unexpected contrary to what history has shown so far. For example, if nominal wages are larger than normal there may be a leftward shift if the expansionary policy is used creating a wage-price spiral. Several of the theories we now know about economics are soley due to a blunder-hypothesis combination. Since the policies have not had a historically longterm existence, it is possible that some actions taken rely too strongly on short term effects(see quote at the bottom). Also seasonal variation can effect the demand for loans thereby reducing the banks need for money(cyclical asymetry and changes in banking).



Tools of the Monetary Policy:
   The Fed has three methods of controlling money.
  • Discount Rate: The interest rate banks pay to borrow money from the Fed. Banks are more likely to borrow the lower the rate is. The Fed can increase the money supply by decreasing the discount rate and increase it by increasing the discount rate. The Federal Funds rate is what banks charge to each other for making overnight loans of reserves. The Prime Interest rate moves with the Federal funds rate(nearly same graph shape), it serves to give the cheapest loan to the customers with the least risk or "optimum credit".
  • Open Market Operations: Buying and selling of Government securities by the Fed(bonds, bills, notes on the open market). By selling bonds the individuals buying them losses that amount of money which is simply "deleted" from the money supply and by buying them, it increases the money supply.
  • Reserve Ratio: The higher the reserve ratio the greater the portion of deposits a bank must hold as reserves as to lower their ability to give loans. The multiplier decreases and results in a creation of less total deposits.

    "In the long run, we're all dead." -Keynes