Assignment: Discussion Brief #2

Option 2: Read “Monetary Policy: What Are Its Goals? And How Does It Work?” & “Minsky’s
Financial Instability Hypothesis” in the Money & Banking folder on D2L, and answer the
following questions:

 What are the goals of US monetary policy?

The main goals of US monetary policy are to promote effectively the goals of
maximum employment, keep the price at the stable level, and moderate long-term
interest rate.
 How does monetary policy affect the real economy, and what role do expectations play
in the monetary transmission mechanism?
Monetary policy affects the real economy through its interest rate, asset price, exchange
rate, and household decisions. In term of interest rate, the monetary policy can change
short-term and long-term interest rate which are two factors that are very important to
the economic activity and employment since those two can impacts household
purchasing decision and company investments.
In terms of asset price, since the monetary can change the rate for US bond and US
investments, it can have a big impact in the dollar value against the other currencies.
About the asset price, with an impacts on business investments and operations,
monetary policy can changes the stock price of the company which will impact the
economy.
Last but not least, the monetary policy can change the spending decisions through the
consumer loans, mortgage loan rate and the working bonus
 What does the Federal Reserve mean when they say that monetary policy is intended to
be accommodative?
Monetary policy is considered to be "accommodative" when it aims to make interest
rates sufficiently low to spur strong enough economic growth to reduce unemployment
or to prevent unemployment from rising.
 Discuss Minsky’s Financial Instability Hypothesis: what did Minsky mean when he
said that “stability is destabilizing”?
He means that the stable economy itself could generate shocks through its own internal
dynamics. He believed that during periods of economic stability, banks, firms and other
economic agents become complacent.
 How does Minsky’s work help us to understand why financial markets may be a source
of risk in the economy?
He showed that the financial markets always undergo a credit cycle after a financial
crisis which is the disappointing status of the economy. To be specific,

FIN-516 | Managerial Macroeconomics

 In the first stage, soon after a crisis, banks and borrowers are cautious. Loans are made
in modest amounts and the borrower can afford to repay both the initial principal and
the interest.

As confidence rises banks begin to make loans in which the borrower can only afford to
pay the interest. Usually this loan is against an asset which is rising in value. Finally,
when the previous crisis is a distant memory, we reach the final stage - Ponzi finance.
At this point banks make loans to firms and households that can afford to pay neither
the interest nor the principal. Again this is underpinned by a belief that asset prices will
rise.

The easiest way to understand is to think of a typical mortgage. Hedge finance means a
normal capital repayment loan, speculative finance is more akin to an interest-only loan
and then Ponzi finance is something beyond even this. It is like getting a mortgage,
making no payments at all for a few years and then hoping the value of the house has
gone up enough that its sale can cover the initial loan and all the missed payments. You
can see that the model is a pretty good description of the kind of lending that led to the
financial crisis.

 How do the central bank’s desire to stabilize the economy and Minsky’s belief that a
stable economy creates risk interact to create cycles of credit risk?

Please share any other thoughts you have on this week’s topics or readings.

FIN-516 | Managerial Macroeconomics