17.1 Monetary Policy Targets and Goals

17.1 Monetary Policy Targets and Goals #Notebook

The economies tend to cycle through periods of boom and bust, of expansion and contraction. 

The Fed used to exacerbate these cycles by making the highs of the business cycle higher and the lows lower.

The postwar recession hurt the Fed’s revenues because the volume of rediscounts shrank.

Roosevelt Recession of 1937–1938 was caused by raising the reserve requirement, a new policy placed in its hands by FDR and his New Dealers in the Banking Act of 1935.

During World War II, the Fed wasn’t very independent. After the war, demand increased, coupled with quantity rationing, the floodgates of inflation opened. 

Basically, wealth would increase (decrease), driving interest rates up (down), inducing the Fed to buy (sell) bonds, thereby increasing (decreasing) MB and thus the money supply (MS). 

However, if interest rates rose or bond prices declined due to an increase in inflation, the Fed would also buy bonds to support their prices, thereby increasing the money supply and higher inflation. 

When the Great Inflation began in the late 1960s, nominal interest rates rose above those set by the Fed, and credit crunches resulted because the quantity demanded exceeds the quantity supplied by the market. 

Banks made fewer loans because they couldn’t attract the deposits they needed. During high interest rates, entrepreneurs couldn’t obtain financing for good business ideas, decreasing economic activity. 

By the late 1980s, the Fed, under Alan Greenspan began to engage in anti-cyclical policies, raising the federal funds rate before inflation became a problem and by lowering the federal funds rate at the first sign of recession. Since then, the natural swings of the macroeconomy have been much more docile than hitherto, until the crisis of 2007–2008. 

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.