Chapter 18 - Monetary policy: Stabilizing the domestic economy. In this chapter, students will be able to understand: The Federal Reserve has four conventional monetary policy tools, the European Central Bank's primary objective is price stability, monetary policymakers use several tools to meet their objectives, the Taylor rule is a simple equation that describes movements in the federal funds rate,. | Chapter Eighteen 18- Introduction There are three interest rates: The federal funds rate, The discount rate, and The deposit rate. These are the primary tools of monetary policy during normal times. In a financial crisis, central banks may also adjust the size and composition of their balance sheet. 18- Introduction Interest rates play a central role in all of our lives. They are the cost of borrowing and the reward for lending. Higher rates restrict growth of credit. The business press is constantly speculating about whether the FOMC will change its target. 18- Introduction Between September 2007 and December 2008, the FOMC lowered its target for the federal funds rate 10 times. This was the first time since the 1930s that the Fed hit the zero bound on the nominal federal funds rate. Banks can always hold cash paying zero interest. They will never choose to lend their reserves at a negative nominal rate. The nominal policy rate therefore faces a zero bound: | Chapter Eighteen 18- Introduction There are three interest rates: The federal funds rate, The discount rate, and The deposit rate. These are the primary tools of monetary policy during normal times. In a financial crisis, central banks may also adjust the size and composition of their balance sheet. 18- Introduction Interest rates play a central role in all of our lives. They are the cost of borrowing and the reward for lending. Higher rates restrict growth of credit. The business press is constantly speculating about whether the FOMC will change its target. 18- Introduction Between September 2007 and December 2008, the FOMC lowered its target for the federal funds rate 10 times. This was the first time since the 1930s that the Fed hit the zero bound on the nominal federal funds rate. Banks can always hold cash paying zero interest. They will never choose to lend their reserves at a negative nominal rate. The nominal policy rate therefore faces a zero bound: it will never fall below zero. 18- Introduction Even setting the federal fund rate target at essentially zero wasn’t enough to stabilize the economy. The crisis had undermined the willingness and ability of major financial intermediaries to lend. In this environment the Fed moved to substitute itself for dysfunctional intermediaries and markets. This significantly altered the Fed’s balance sheet. 18- 18- Introduction To steady the financial system and the economy after the crisis, the Fed utilized its three principal conventional policy tools: The federal funds rate target, The rate for discount window lending, and The deposit rate. They did so to the fullest extent possible to support economic activity. 18- Introduction Policymakers then proceeded to develop and use a variety of unconventional policy tools including: Commitments to keep interest rates low over time, and Massive purchases of risky assets in thin, fragile markets. These unconventional measures added
