Monetary Policy

• action of a central bank to achieve sustainable economic growht by adjusting the money supply

Adjust the reserve ratio = minimum a bank has to keep of a deposit as a bank reserve

• Increase reserve ratio -> Bank has to keep more reserve -> Decrease Money supply

  Limits: Banks are allowed to keep more or people keep cash at home

Adjust Federal Fund Rate = Rate for banks to lend money inbetween them

• Increase Federal Fund Rate = Decreae Money Supply

Open Market Operation = Tool for influencing FFR

• Expansionary OMO = Central bank buys T-Bills from bank -> Increase Money Supply

• Contractionary OMO = Central bank sells T-bills to bank —> Decrease Money Supply

Negative AD shock, e.g. Animal Spirits (=emotions and fear)

• With an negative AD shock (and no adjustment by Monetary Policy), in the long run, you would get equilbrium with lower inflation rate and same growth rate

• But in the short run, real GDP growth rate goes down, might even be negative —> negative conseuquences, Recession

• Central Bank can help with Money Supply

1. Data Quality (Data often reviewed after years)

2. Timing (actions might take months)

3. Control is incomplete and imperfect (e.g. dependance of banks)

Negative Real Shock (e.g. Oil Shock)

• Negative Real Shock = Less growth and higher inflation

• To decrease inflation —> Decrease Money Supply

• To increase growth —> Increase Money Supply (with a even higher inflation)

• AD Shock and Real Shock often come together