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ECON102 Chapter Notes - Chapter 2.5: Monetary Policy, Reserve Requirement, Money Supply

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pinkgoose715
12 Dec 2017
School
University of Waterloo
Department
Economics
Course
ECON102
Professor
Corey Van De Waal

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Document Summary

Monetary policy: the use of interest rates and the money supply to influence the level of economic activity. The central bank usually controls the money supply, such as the uk"s bank of england. They are independent from the government, so they are less prone to political pressure from the government. The central bank sets the base/discount rate, which in turn influences the interest rate charged by financial institutions. For instance natwest will have an interest rate from mortgages above the base rate, but if the base rate, which they are charged, increases then they will also increase the interest that they charge. The interest rate: the reward for saving and the cost of borrowing money, which is the price of money. This is charged on mortgages, loans to businesses and credit cards. It depends on the risk involved for the lender, as well as the base rate.

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Related Questions

Macroeconomics (7th edition) by Olivier Blanchard

10. Monetary policy in a liquidity trap
Suppose that money demand is given by Md = $Y(0.25 - i) as long as interest rates are positive. The questions below then refer to situations where the interest rate is zero.

a. What is the demand for money when interest rates are zero and $Y = 80?

b. If $Y = 80, what is the smallest value of the money supply at which the interest rate is zero?

c. Once the interest rate is zero, can the central bank continue to increase the money supply?

d. The United States experienced a long period of zero interest rates afer 2009. Can you find evidence in the text that the money supply continued to increase over this period?

e. Go to the database at the Federal Reserve Bank of St. Louis known as FRED. Find the series BOGMBASE (the monetary base) and look at its behavior from 2010 to 2015. What happened to the monetary base? What happened to the federal funds rate in the same period?

13. As we observed in this chapter, central banks, rather than purposefully setting the level of the money supply, usually set a target level for a short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. (When people need more money for a reason other than a change in $4,010 $570.3 $641.0 CHAPTER 15 Money, Interest Rates, and Exchange Rates 383 the interest rate, the money supply therefore expands, and it contracts when they wish to hold less.) a. Describe the problems that might arise if a central bank sets monetary policy by holding the market interest rate constant. (First, consider the flexible-price case, and ask yourself if you can find a unique equilibrium price level when the central bank simply gives people all the money they wish to hold at the pegged interest rate. Then consider the sticky-price case.) b. Does the situation change if the central bank raises the interest rate when prices are high, according to a formula such as where a is a positive constant and a target price level? c. Suppose the central bank’s policy rule is where u is a random movement in the policy interest rate. In the overshooting model shown in Figure 15-12, describe how the economy would adjust to a permanent one-time unexpected fall in the random factor u, and say why. You can interpret the fall in u as an interest rate cut by the central bank, and therefore as an expansionary monetary action. Compare your story with the one depicted in Figure 15-13. Figure 15-12: http://gyazo.com/3d32377d42b5c9584e17b3c5e40aafaa

Figure 15-13: http://gyazo.com/1fa467e253e320f61da17532fa8d2b58

As we observed in this chapter, central banks, rather than purposefully setting the level of the money supply, usually set a target level for a short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. (When people need more money for a reason other than a change in the interest rate, the money supply therefore expands, and it contracts when they wish to hold less.)

A. Describe the problems that might arise if a central bank sets monetary policy by holding the market interest rate constant. (First, consider the flexible-price case, and ask yourself if you can find a unique equilibrium price level when the central bank simply gives people all the money they wish to hold at the pegged interest rate. Then consider the sticky-price case.)

B. Does the situation change if the central bank raises the interest rate when prices are high, according to a formula such as R - R0= a(P - P0), where a is a positive constant and P0a target price level?

C.Suppose the central bank’s policy rule is R - R0= a(P - P0) + u, where u is a random movement in the policy interest rate. In the overshooting model shown in Figure 15-12, describe how the economy would adjust to a permanent one-time unexpected fall in the random factor u, and say why. You can interpret the fall in u as an interest rate cut by the central bank, and therefore as an expansionary monetary action.