Current Events:
The Ch. 19 Multiple Choice Test will be Friday. Be sure to consult the Ch. 19 Test Prep page for both the Multiple Choice Test and the TBA Ch. 19 Short Answer Test.
We will pick up where we left off in Chapter 22, Monetary Policy; we can begin Ch. 23.
Chapter Overview
Having introduced the Federal Reserve System and its tools for monetary policy in Chapter 21, this chapter begins by considering how money affects the economy (both the long-run quantity theory and the short-run analysis of interest rate channels are covered). The next section discusses the lags in monetary policy (you may wish to relate this section to the corresponding section in the chapter on fiscal policy). The chapter continues with a section on implementing monetary policy that raises the questions of rules versus discretion and which (if any) targets should be used by the Federal Reserve. A final consideration of transparency and the Fed concludes the chapter.
Chapter Outline
Transparency and the Federal Reserve
Ideas for Capturing Your Classroom Audience
Chapter Checkpoints
Transparency is controversial within the Fed, particularly with regard to “forwardlooking transparency.” Some believe that statements about the Fed’s views of where the economy is headed can tie its hand by revealing likely future courses of action. (NOTE: The key to understanding that view is believing that if the market expects the Fed to change rates (in either direction) it will change bond purchasing behavior and so will affect interest rates even before the Fed actually does anything, in effect making the Fed’s action, when it comes, have no further effect on the markets.)
This section references an article by Greg Ip, “The Fed’s Big Question: Not What to Do, But What to Say” (The Wall Street Journal, October 27, 2003, page A1). The
debate about transparency that occurs within the Fed cites two articles by William
Poole (President of the Federal Reserve Bank of St. Louis); they are “Fed
Transparency: How, Not Whether,” from the Federal Reserve Bank of St. Louis
Review, November/December 2003 and “FOMC Transparency,” also from the
Federal Reserve Bank of St. Louis Review, January/February 2005.
“Fed
Transparency: How, Not Whether,” from the Federal Reserve Bank of St. Louis
Review, November/December 2003
Cf. http://research.stlouisfed.org/publications/review/03/11/poole.pdf
“FOMC Transparency”
Cf. http://research.stlouisfed.org/publications/review/05/01/Poole.pdf
Past issues of the review are available on the Bank’s Web site at http://research.stlouisfed.org/
publications/review/past/.
Also cited is a response by Ben Bernanke, Thomas Laubach, Frederic Mishkin, and
Adam S. Posen to a review of their book Missing the Mark: The Truth About
Inflation Targeting. Writing in Foreign Affairs (September/October 1999), the
authors restate their theses in response to the review that had been written by
James K. Galbraith. The response can be read on the Web at: http://www.
foreignaffairs.org/19990901faresponse1013/ben-bernanke-thomas-laubachfrederic-
mishkin-adam-s-posen/missing-the-mark-the-truth-about-inflationtargeting.
html.
Examples Used in the End-of-Chapter Questions
Question 1 cites an article by Brian Wesbury titled “Economic Rehab” from The Wall
Street Journal, June 7, 2006, p. A14. In the article Wesbury suggests that Bernanke
is being unfairly criticized for a series of missteps. To put this in the context of
transparency, look at the list of Bernanke statements compiled by Liz Rappaport of
TheStreet.com. Full text of article is available at http://www.thestreet.com/markets/
marketfeatures/10289904.html but a concise table with “translations” can be found
at: http://bigpicture.typepad.com/comments/2006/06/tracking_bernan.html.
Question 3 references the European Central Bank. For a statement on the Bank’s
policy with regard to inflation and other information about its functions and objectives, see its Web site at http://www.ecb.int/mopo/html/index.en.html.
Question 9 could be extended to a discussion of whether or not there is such a thing as a “liquidity trap.” If you choose to address that topic, recent experiences in Japan provide interesting illustrations.
Question 12 discusses transparency and inflation targets. For more discussion of
this topic with regard to Federal Reserve Chairman Ben Bernanke (and Governor
Frederic Mishkin) see the article from The Economist titled “The Federal Reserve’s
Chairman Hitting his Stride” (February 1, 2007, available on the Web at http://www.economist.com/finance/displaystory.cfm?story_id=8641615).
For Further Analysis
Using the AS/AD Model to Explore the Impacts of Expansionary Monetary
Policy
This example can be used as an in-class small group exercise or as an individual inclass exercise. It is designed to complement the text’s material by employing the graphical analysis of the AS/AD model to illustrate the effects of expansionary monetary policy when the economy is below full employment and when it is above full employment. It would not be difficult to adapt the handout to have students consider contractionary policy as well.
The third question in the handout can be deleted if desired; it asks students to
explain the circumstances under which cuts in the target federal funds rate might
NOT occur. This can be useful if you want to discuss the time period during which
the Fed kept the target rate unchanged.
Note that #13 of the end-of-chapter Questions and Problems uses only short-run
analysis and asks students to compare monetary policy actions in the context of
demand shocks versus supply shocks. The purpose of this exercise is to show how
monetary policy can make things worse if the current position of the economy versus long-run aggregate supply is unclear.
Web-Based Exercise
This example can be used as a small group exercise or as an individual exercise.
The exercise provides an opportunity for students to apply the material in the chapter about the FOMC and how it communicates with the public by having students
read the latest press release. It is advisable to review how the process works before giving this assignment (for example, what is the target federal funds rate?). You may also wish to assign more than one press release to have students “track” the FOMC’s views over time.
Links to all the FOMC statements can be found at: http://www.federalreserve.
gov/FOMC/#calendars.
Reading the Tea Leaves: The Latest from the FOMC
Read the latest press release from the FOMC. Visit its Web site at: http://www.
federalreserve.gov/FOMC/#calendars and click on the “Statement” link for the most
recent date on the calendar.
After reading the statement, answer the following:
1) What did the FOMC decide to do?
2) What is the “tilt” statement embedded in the statement?
3) Was the vote on the statement unanimous? What do you conclude from the
voting result?
Tips from a Colleague
This material can be of great interest to students when they realize how critical the Fed’s conduct of monetary policy is to the action in financial markets. You may wish to create a compilation of articles in the business/financial press in advance of an FOMC meeting and then those following it to emphasize how expectations were formed about the Fed’s actions and whether those expectation were met or not.
Using the AS/AD Model to Explore the Impacts of Expansionary Monetary Policy
The job of the FOMC is to assess the current (and future) path of the economy and decide whether or not monetary policy action is indicated at any point in time. One of the many challenges they face is trying to evaluate where the economy is relative to its full employment level.
References
Milton Friedman - Socialized Medicine, 9:37
Nobel Laureate Economist Milton Friedman explores the unsettling dynamics set into motion when government imposes itself into the health care system. (1978)
Hayek on Milton Friedman and Monetary Policy, 4:56
Friedrich Hayek discusses Milton Friedman's Monetarism and monetary policy.
For more on Hayek's ideas on monetary policy see
Choice in Currency: A way to stop inflation
(for a concise summary) at
http://www.iea.org.uk/files/upld-book...
or see The Denationalisation
of Money for a more a more detailed proposal at
http://www.iea.org.uk/files/upld-book...
This is an excerpt from a longer interview which can be found here http://www.vimeo.com/4063439
Milton Friedman on Slavery and Colonization, 8:43
Modern monetary theory - Mitchell and Wray
This is a series of Modern monetary theory interviews - Professors Bill Mitchell and Randy Wray. See billy blog (http://bilbo.economicoutlook.net/blog) for more information on this approach to macroeconomics. You can also get more information from Centre of Full Employment and Equity (http://e1.newcastle.edu.au/coffee).
Questions asked:
A fundamental or central part of the research of both of you is centred on the nature of money. Could you perhaps talk a little bit about the nature of money and particularly explain to non-economists what fiat money is and what the implications it has on policy formation?
The Ch. 19 Multiple Choice Test will be Friday. Be sure to consult the Ch. 19 Test Prep page for both the Multiple Choice Test and the TBA Ch. 19 Short Answer Test.
Email HW to gmsmith@shanahan.org
1. Be sure to review Chapters 20-22 (we will have Tests on this material as well, TBA). Some students have asked to be tested as close as possible after covering the material.
2. The Chapter review section references an article by Greg Ip, “The Fed’s Big Question: Not What to Do, But What to Say” (The Wall Street Journal, October 27, 2003, page A1). The debate about transparency that occurs within the Fed cites two articles by William Poole (President of the Federal Reserve Bank of St. Louis); they are “Fed Transparency: How, Not Whether,” from the Federal Reserve Bank of St. Louis Review, November/December 2003 and “FOMC Transparency,” also from the Federal Reserve Bank of St. Louis Review, January/February 2005.
“FedTransparency: How, Not Whether,” from the Federal Reserve Bank of St. Louis
Review, November/December 2003
Cf. http://research.stlouisfed.org/publications/review/03/11/poole.pdf
“FOMC Transparency”
Cf. http://research.stlouisfed.org/publications/review/05/01/Poole.pdf
Read both articles and summarize--in three paragraphs--the issues related to transparency and the Fed.
3. As review for HW, typical questions that you may encounter on the actual AP Economics Macro Test are included daily:
Inflation, Unemployment, and Stabilization Policies, Review Questions
a) an increase in RGDP
b) a lower unemployment rate
c) an inflation spiral that could become "hyperinflationary"
d) a recession
e) constant price level
There is no #11 & #12.
13. The phrase "monetizing the deficit" refers to
a) inflation reducing the real value of the debt
b) the Federal Reserve buying some of the government deficit
c) the Treasury repaying the debt
d) the Treasury issuing short-term securities in place of long-term securities
e) the Federal Reserve issuing government securities
14. An increase in the money supply causes
a) a long-run increase in the level of output
b) an increase in the level of output over both the long-run and the short-run
c) a short-run increase in the level of output
d) no change in the level of output
e) a short-run increase and a long-run decrease in the level of output
15. "Crowding out" refers to
a) an increase in investment caused by an increase in government spending
b) a decrease in investment caused by an increase in government spending
c) a decrease in government spending caused by a decrease in investment
d) an increase in investment caused by a decrease in government spending
e) a decrease in government spending caused by an increase in investment
