CHAPTER 5

Monetary Theory and Policy

CHAPTER 5 OVERVIEW
This chapter will: A. Describe the impact of monetary policy B. Explain the tradeoffs involved in monetary policy C. Describe how financial market participants monitor and forecast the Feds policies D. Explain how monetary and fiscal policies are related

A. Impact of Monetary Policy

1. Correcting a Weak Economy a. Fed can stimulate the economy by creating a loose-money policy and engages in

1.)
2.)

buying government securities

lowering the discount rate

3.)

lowering the reserve requirement

A. Impact of Monetary Policy

2. Correcting High Inflation a. The Fed can constrain economic activity when it creates a tight-money policy and 1.) sells government securities 2.) raises the discount rate 3.) increases the reserve requirement

B. Tradeoff in Monetary Policy

1. The Tradeoff
a. Studies indicate there exists an inverse relationship between inflation and unemployment the lower the unemployment, the greater the inflation, the higher the unemployment, the lower the inflation

B. Tradeoff in Monetary Policy

2. When inflation is high, tight money policy is considered.
Tradeoff is higher unemployment

B. Tradeoff in Monetary Policy

3. When unemployment is high, loosemoney policy is considered. Trade off is higher inflation

C. Monitoring and Forecasting the Feds Policy

1. Economic Indicators Monitored by the Fed a. Indicators of Economic Growth 1.) GDP 2.) Industrial production index 3.) Unemployment rate 4.) Consumer confidence surveys b. Index of Leading, Coincident, and Lagging Indicators
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C. Monitoring and Forecasting the Feds Policy

2. Indicators of Inflation
a. Producer and Consumer Price Indexes

b. Other Indicators

C. Monitoring and Forecasting the Feds Policy

3. How the Fed uses Indicators
4. Index of Leading Economic Indicators

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D. Integrating Monetary and Fiscal Policies

1. Framework a. Monetary and Fiscal Policy Affect Interest Rates over Time 1.) Monetary policy has an indirect effect on the demand for funds 2.) U.S. fiscal policy the demand for funds through the a.) U.S. budget b.) U.S. business tax rates
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Homework
Questions: 1, 2, 3, 7, 11, 12, 13

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