Tài liệu Thị trường tài chính và các định chế tài chính_ Chapter 05 pdf

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Chapter 5
Monetary Theory and Policy
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Monetary theory

Tradeoff faced by the Fed

Economic indicators monitored by the Fed

Lags in monetary policy

Assessing the impact of monetary policy

Integrating monetary and fiscal policies

Global effects of monetary policy
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Monetary Theory

Pure Keynesian Theory

One of the most popular theories influencing the Fed

Developed by John Maynard Keynes


Suggests how the Fed can affect the interaction
between the demand for money and the supply of
money to influence:

Interest rates

The aggregate level of spending

Economic growth
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Monetary Theory (cont’d)

Pure Keynesian Theory (cont’d)

Can be explained by using the loanable funds
framework

Demand for and supply of loanable funds
determine the equilibrium interest rate

The business investment schedule illustrates the
inverse relationship between interest rates on
loanable funds and the level of business
investment
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Monetary Theory (cont’d)

Pure Keynesian Theory (cont’d)

Correcting a weak economy


The Fed would use open market operations to increase the
money supply

A higher level of the money supply would reduce interest
rates

Lower interest rates encourage more borrowing and
spending

Keynesian philosophy advocates an active role for the
government in correcting economic problems
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Monetary Theory (cont’d)
S
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Correcting a Weak Economy
D
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i
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i
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S
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Demand and Supply of Loanable Funds
Business Investment Schedule
i
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i

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B
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B
2
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Monetary Theory (cont’d)

Pure Keynesian Theory (cont’d)

Correcting high inflation

The Fed would sell Treasury securities (decrease
the money supply)

A lower level of the money supply reduces the
level of spending

Less spending slows economic growth and
reduces inflationary pressure (demand-pull
inflation)
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Monetary Theory (cont’d)
S
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Correcting High Inflation
D
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i
1

i
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S
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Demand and Supply of Loanable Funds
Business Investment Schedule
i
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i
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B
2
B
1
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Monetary Theory (cont’d)

Pure Keynesian Theory (cont’d)

Effects of a credit crunch on a stimulative policy

The economic impact of monetary policy depends on the
willingness of banks to lend funds

If banks are unwilling to extend credit despite a stimulative
policy, the result is a credit crunch

A credit crunch can occur during a restrictive policy since
some borrowers will not borrow because of the high interest
rates

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Monetary Theory (cont’d)

Quantity Theory and the Monetarist approach

The quantity theory suggests a particular relationship
between the money supply and the degree of economic
activity in the equation of exchange:

Velocity is the average number of times each dollar
changes hands per year

The right side of the equation is the total value of goods
and services produced

If velocity is constant, a change in the money supply will
produce a predictable change in the total value of goods
and services
QPMV
G
=
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Monetary Theory (cont’d)

Quantity Theory and the Monetarist approach
(cont’d)

An early form of the theory assumed a constant Q

Assumes a direct relationship between the money supply

and prices

Under the modern quantity theory of money,
the constant quantity assumptions has been
relaxed

A direct relationship exists between the money supply
and the value of goods and services
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Monetary Theory (cont’d)

Quantity Theory and the Monetarist approach
(cont’d)

Velocity represents the ratio of money stock to
nominal output

Velocity is affected by any factor that influences
this ratio:

Income patterns

Factors that change the ratio of households’ money
holdings to income

Credit cards

Inflationary expectations
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Monetary Theory (cont’d)


Comparison of the Monetarist and Keynesian
Theories

The Monetarist approach advocates stable, low
growth in the money supply

Allows economic problems to resolve themselves

Keynesian approach would call for a loose
monetary policy to cure a recession
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Monetary Theory (cont’d)

Comparison of the Monetarist and Keynesian
Theories (cont’d)

Monetarists are concerned about maintaining low
inflation and are willing to tolerate a natural rate of
unemployment

Keynesians focus on maintaining low
unemployment and are willing to tolerate any
inflation that results from stimulative monetary
policies
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Monetary Theory (cont’d)

Theory of Rational Expectations


Holds that the public accounts for all existing information
when forming its expectations

Suggests that households and business will use historical
effects of monetary policy to forecast the impact of an
existing policy and act accordingly

Households spend more with a loose monetary policy to avoid
inflation

Businesses will increase their investment with a loose
monetary policy to avoid higher costs

Labor market participants will negotiate higher wages with a
loose monetary policy

Supports the Monetarist view that changes in monetary
policy do not have a sustained impact on the economy
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Monetary Theory (cont’d)

Which theory is correct?

The FOMC recognizes the virtues and limitations
of each theory

The FOMC adjusts monetary growth targets to control
economic growth, inflation, and unemployment

Recognizing the Monetarist view, the FOMC is

concerned about the inflation resulting from a loose
monetary policy
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Tradeoff Faced by the Fed

Ideally, the Fed would like:

Low inflation

Steady GDP growth

Low unemployment

There is a negative relationship between
unemployment and inflation

Phillips curve

A tight money policy can curb inflation but increase
unemployment and vice versa
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Tradeoff Faced by the Fed (cont’d)

Impact of other forces on the tradeoff

Cost factors such as energy costs and
insurance costs can influence the tradeoff

When both inflation and unemployment are
high, Fed members may disagree as to the

type of monetary policy that should be
implemented
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Tradeoff Faced by the Fed (cont’d)

Impact of other forces on the tradeoff (cont’d)

How the Fed’s focus shifted during the Persian Gulf War

There were numerous indications of a possible recession in the
summer of 1990

The abrupt increase in oil prices placed upward pressure on U.S.
inflation

How the Fed’s emphasis shifted during 2001–2004

The focus shifted from high inflation to the weak economy over time

From January to December 2001, the FOMC reduced the targeted
federal funds rate ten times

In 2002 and 2003, the Fed reduced the federal funds target rate
twice
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Economic Indicators Monitored by
the Fed

Indicators of economic growth


Gross domestic product (GDP)

Measures the total value of goods and services
produced

Measured each month

The most direct indicator of economic growth

Level of production

A high level indicates strong economic growth and
can result in increased demand for labor
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Economic Indicators Monitored by
the Fed (cont’d)

Indicators of economic growth (cont’d)

National income

The total income earned by firms and individual employees

A strong demand for goods and services results in a large
amount of income

Unemployment rate

Does not necessarily indicate the degree of economic growth


Can decrease in weak economic growth periods if new jobs
are created
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Economic Indicators Monitored by
the Fed (cont’d)

Indicators of economic growth (cont’d)

Industrial production index

Retail sales index

Home sales index

Composite index

Consumer confidence surveys
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Economic Indicators Monitored by
the Fed (cont’d)

Indicators of inflation

Producer and consumer price indexes

The PPI measures prices at the wholesale level

The CPI measures prices on the retail level

Both indexes are used to forecast inflation


Agricultural and housing price indexes also exist

Other indicators

Wages, oil prices, transportation costs, the price of
gold, indicators of economic growth
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Economic Indicators Monitored by
the Fed (cont’d)

How the Fed uses indicators

The Fed uses indicators to anticipate how
economic conditions will change and then
determines what monetary policy would be
appropriate

Weak economic conditions suggest an
expansionary monetary policy

High productivity and employment suggest a
restrictive monetary policy
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Economic Indicators Monitored by
the Fed (cont’d)

Index of Leading Economic Indicators

The Conference Board publishes indexes of leading,

coincident, and lagging economic indicators

Leading economic indicators are used to predict future
economic activity

Three consecutive monthly changes in the same direction
suggest a turning point in the economy

Coincident economic indicators reach their peaks and
troughs at the same time as business cycles

Lagging economic indicators tend to rise or fall a few
months after business-cycle expansions and contractions