Does McdonaldS Offer A Model Which Other Businesses Should Follow?

Fed And Monetary Policy

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Justin McVay Period 4 Macroeconomics erm Paper !"#"$A% $"&"$V" AN# M'N" A$( P'%)*( Monetary policy affects the economic and financial decisions of virtually all of us from workers to +orrowers to investors ,$ukeyser -./01 %ouis $ukeyser wrote2 )f we want monetary policy to play its proper role in a true national economic reconstruction2 the authentic task is to get the !ed to stop +ouncing like a *hinese Ping3Pong +all2 switching every few months +etween the inflationary effect of pumping far too much money into the economy and cramping2 recessionary effect of supplying far to little ,$ukeyser -.401 And2 +ecause the 4& is the largest economy in the world2 its monetary policy also has significant economic and financial effects on other countries1 he o+5ect of monetary policy is to influence the performance of the economy2 as reflected in such factors as inflation2 economic output2 and employment1 )t does so +y affecting demand1 Most people are familiar with the fiscal policy tools that affect demand2 such as ta6es and government spending1 %ess familiar is monetary policy7 it is conducted +y the !ederal $eserve &ystem2 the nation8s central +ank2 and it influences demand mainly +y raising and lowering short3term interest rates1 he !ederal $eserve &ystem ,the !ed0 is the nation8s central +ank1 )t was esta+lished +y an Act of *ongress in -9-: and consists of the seven mem+ers of the Board of ;overnors in <ashington2 #* and twelve !ederal $eserve #istrict Banks1 *ongress structured the !ed to +e independent within the government1 <hat that means is although the !ed ) accounta+le to *ongress2 it is insulated from day3to3day political pressures1 his reflects the conviction held +oth the 4& and in many other countries that the people who control the country8s money supply should +e independent of the people who frame the government8s spending decisions1 Most studies of central +ank independence rank the !ed among the most independent in the world ,<orld =>01 "ach reserve +ank President is appointed to a five3year term +y that +ank8s Board of #irectors2 su+5ect to final approval +y the Board of ;overnors1 his procedure adds to independence2 +ecause the directors of each reserve +ank2 who are not political appointees2 provide a regional cross3section of interests2 including depository institutions2 nonfinancial +usinesses2 la+or2 and the pu+lic1 he !ed is structured to +e self3sufficient in the sense that it meets its operation e6penses primarily from the interest earnings on its portfolio of securities1 herefore2 it is independent of *ongressional decisions a+out funding1 "ven though the !ed is independent of *ongressional funding and administrative control2 it is ultimately accounta+le to *ongress and comes under government audit and review1 he *hairman2 other governors2 and $eserve Bank Presidents report regularly to the *ongress on monetary policy2 and a variety of other issues2 and meet with senior Administration officials to discuss the !ederal $eserve8s and the federal government8s economic programs ,<orld =?01 <ithin the !ed2 the !ederal 'pen Market *ommittee2 or !'M*2 has the primary responsi+ility for conducting monetary policy1 he !'M* meets in <ashington eight times a year and has twelve mem+ers@ the seven mem+ers of the Board of ;overnors2 the President of the !ederal

$eserve Bank of New (ork2 and four of the other $eserve Bank Presidents2 who serve in rotation1 he remaining $eserve Bank Presidents contri+ute to the committee8s discussions and deli+erations1 )n addition2 the directors of each $eserve Bank contri+ute to monetary policy +y making recommendations a+out the appropriate discount rate2 which are su+5ect to final approval +y the ;overnors1 he goals of 4& Monetary Policy according to the !ederal $eserve Act states that they are to promote ma6imum employment2 sta+le prices2 and moderate long3term interest rates1 he goals of monetary policy are inconsistent1 he +elief that a 4A unemployment rate and sta+le prices are inconsistent is shaped +y the widely accepted natural rate hypothesis1 )t argues that monetary policy has no effect on the economy8s long3run eBuili+rium unemployment rate2 which is often called the natural rate of unemployment1 he reason is that2 in the long run2 unemployment depends on so3called real factors such as technology and people8s preferences for saving2 risk2 and work effort7 these factors are +eyond the reach of monetary policy1 Most current estimates place the natural rate of unemployment in the range /1?/A and =1?/A1 *onsistent attempts to e6pand the economy +eyond its potential for production will result in higher and higher inflation2 while ultimately failing to produce lower average unemployment1 herefore2 most economists would argue that there are no long3term gains from consistently pursuing e6pansionary policies1 he crowding out of investment is traced to the failure of monetary policy ,"isner /901 Although there are some negatives with monetary policy2 it can determine the economy8s average rate of inflation in the long run1 hat is important for the economy2 +ecause high inflation can hinder economic growth in a couple of ways1 )t adds an inflation risk premium to long3term interest rates and it complicates the planning and contracting +y +usiness and la+or that are so essential to capital formation1 Cigh inflation also hinders economic growth in other ways1 !or e6ample2 +ecause the ta6 system isn8t inde6ed to inflation2 high inflation helps and hurts different sectors of the economy1 )n addition2 it makes people spend their time hedging against inflation instead of pursuing more productive activities1 Because the !ed can determine the economy8s average rate of inflation2 some commentators and some mem+ers of *ongress have emphasiDed the need to define the goals of monetary policy in terms of price sta+ility2 which is achieva+le1 But the !ed2 like most central +anks2 cares a+out +oth inflation and measures of the short3run performance of the economy1 Cowever2 pursuing multiple goals can create conflicts for policy1 'ne kind of conflict involves deciding which goal should take precedence at any point in time1 Another kind of conflict is the potential for pressure from the political arena1 he !ed is somewhat insulated from the pressure of politics +y its independence2 which allows it to achieve a more appropriate +alance +etween short3run and long3run o+5ectives1 he !ed will not use monetary policy to help a region in a recession1 'ften enough2 some state or region is going through a recession of its own while the national economy is prosperous1 But the !ed can not concentrate its efforts to e6pand the weak region for two reasons1 !irst2 monetary policy works through credit markets2 and since credit markets are linked nationally2 the !ed simply has no way to direct stimulus to any particular part of the country that needs help1 &econd2 if the !ed stimulated whenever any state had economic hard times2 it would +e stimulation much of the time2 and this would mean higher inflation1 he !ed can not control inflation or unemployment directly7 instead2 it influences them indirectly2 mainly +y raising or lowering short3term interest rates1 he ma5or tools the !ed uses to affect interest rates are open market operations and the discount rate2 +oth of which work through the market for +ank reserves1 Banks and other depository institutions are legally reBuired to hold a specific amount of funds in reserves1 *urrently2 +anks must hold :3-.A of the funds they have in interest +earing and non interest +earing checking accounts as reserves1 he amount of reserves a +ank has to hold changes daily1 <hen +anks need additional reserves on a short3term +asis2 it can +orrow them from other +anks that happen to have more reserves than they need1 hese loans take place in a private

financial market called the federal funds market1 he interest rate on the overnight +orrowing or reserves is called the federal funds rate or simply the funds rate1 )t ad5usts to +alance the supply of and demand for reserves1 he interest rate is also used as an indicator of monetary policy and future economic growth ,&ims E/.01 he prime tool the !ed uses to affect the supply of reserves in the +anking system is open market operations1 his means the !ed +uys and sells government securities on the open market1 hese operations are conducted +y the !ed8s open market trading desk at the !ederal $eserve Bank of New (ork1 )f the !ed wants the funds rate to fall it +uys government securities from a +ank1 he !ed then pays for the securities +y increasing that +ank8s reserves1 As a result2 the +ank now has more reserves than it is reBuired to hold1 &o the +ank can lend these e6cess reserves to another +ank in the federal funds market1 hus2 the !ed8s open market purchase increases the supply of reserves to the +anking system2 and the funds rate falls1 <hen the !ed wants the rate to rise it does the reverse +y selling government securities1 he !ed gets the payment in reserves from +anks2 which lower the supply of reserves in the +anking system2 and funds rate rises ,&egalstad -01 Banks also +orrow reserves from the !ed at their discount windows2 and in that case the interest rate they must pay on this +orrowing is called the discount rate1 he total Buantity of discount window +orrowing is called the discount rate ,<orld =>01 he discount rate plays a role in monetary policy +ecause2 traditionally2 changes in the rate may have signaled to markets a significant change in monetary policy1 A higher discount rate can +e used to indicate a more restrictive policy2 while a lower rate may signal a more e6pansionary policy1 herefore2 discount rate changes are sometimes coordinated with !'M* decisions to change the funds rate ,$ukeyser --401 A final tool of monetary policy are foreign currency operations1 Purchases and sales of foreign currency +y the !ed are directed +y the !'M*2 acting in cooperation with the reasury2 which has overall responsi+ility for these operations1 he !ed does not have targets2 or desired levels2 for the e6change rate1 )nstead2 !ed intervention aims to counter disorderly movements in foreign e6change markets1 )ntervention operations involving dollars2 whether initiated +y the !ed2 the reasury2 or +y a foreign authority2 are not allowed to alter the supply of +ank reserves or the funds rate1 he process of keeping intervention from affecting reserves and the funds rate is called the steriliDation of e6change market operations1 hese are not used as a tool of monetary policy1 he Point of implementing policy through raising or lowering interest rates is to affect people8s and firm8s demand for goods and services1 !or the most part2 the demand for goods and services is not related to the market interest rates Buoted on the financial pages of newspaper2 known as nominal rates1 )nstead2 it is related to real interest ratesFnominal interest rates minus the e6pected rate of inflation1 Monetary policy can affect real interest rates in the short run1 *hanges in real interest rates affect the pu+lic8s demand for goods and services mainly +y altering four things@ +orrowing costs2 the availa+ility of +ank loans2 wealth of households and +usinesses2 and foreign e6change rates1 %ower real rates and a healthy economy may increase +ank8s willingness to lend to +usinesses and households1 his may increase spending2 especially +y smaller +orrowers who have few sources of credit other than +anks1 %ower real rates make common stocks and other such investments more attractive than +onds another de+t instruments7 as a result2 common stock prices tend to rise1 Couseholds with stocks in their portfolios find that the value of their holdings has gone up2 and this increase in wealth makes them willing to spend more1 )n the short run2 lower real interest rates in the 4& also tend to reduce the foreign e6change value of the dollar2 which lowers the prices of the e6ports sold a+road and raises the prices of foreign produced goods1 "6pansionary monetary policy also raises aggregate spending on 4& produced goods and services +y improving the +alance of trade1 A monetary policy that constantly attempts to keep short3term real rates low can lead to high inflation and higher nominal interest rates to protect the purchasing power of the funds due to them1 his is the reason that economic

activity can not keep e6panding +eyond its potential level1 )nitially2 the low real interest rates will cause +usiness and households to increase their +orrowing demands2 and that will push up other longer3term interest rates1 hese tighter credit conditions will tend to cause real interest rates to rise despite the !ed8s attempts to keep them low2 there+y slowing economic activity2 moving it +ack toward its potential level ,"isner E/01 he precise magnitude and timing of the effects of the !ed8s actions on the economy are never perfectly predicta+le1 his is partially +ecause the future course of the economy is su+5ect to many influences +eyond the !ed8s control2 such as government ta6ing and spending policies2 the availa+ility of natural resources like oil2 economic developments a+road2 financial conditions at home and a+road2 and the introduction of new technologies1 )n addition2 human responses to economic incentives are inherently difficult to predict2 and may change over time2 leading to errors in predicting private aggregate spending ,$ukeyser -E401 Monetary policy alone cannot perform an economic miracle1 )t cannot eliminate all fluctuations of the +usiness cycle7 it cannot revitaliDe an outdated industrial machine7 it cannot reform and reduce an over+lown2 arrogant +ureaucracy7 +ut it can perform sta+iliDing functions crucial to the economy of the 4nited &tates of America1 Justin McVay Period 4 Macroeconomics erm Paper !"#"$A% $"&"$V" AN# M'N" A$( P'%)*( Monetary policy affects the economic and financial decisions of virtually all of us from workers to +orrowers to investors ,$ukeyser -./01 %ouis $ukeyser wrote2 )f we want monetary policy to play its proper role in a true national economic reconstruction2 the authentic task is to get the !ed to stop +ouncing like a *hinese Ping3Pong +all2 switching every few months +etween the inflationary effect of pumping far too much money into the economy and cramping2 recessionary effect of supplying far to little ,$ukeyser -.401 And2 +ecause the 4& is the largest economy in the world2 its monetary policy also has significant economic and financial effects on other countries1 he o+5ect of monetary policy is to influence the performance of the economy2 as reflected in such factors as inflation2 economic output2 and employment1 )t does so +y affecting demand1 Most people are familiar with the fiscal policy tools that affect demand2 such as ta6es and government spending1 %ess familiar is monetary policy7 it is conducted +y the !ederal $eserve &ystem2 the nation8s central +ank2 and it influences demand mainly +y raising and lowering short3term interest rates1 he !ederal $eserve &ystem ,the !ed0 is the nation8s central +ank1 )t was esta+lished +y an Act of *ongress in -9-: and consists of the seven mem+ers of the Board of ;overnors in <ashington2 #* and twelve !ederal $eserve #istrict Banks1 *ongress structured the !ed to +e independent within the government1 <hat that means is although the !ed ) accounta+le to *ongress2 it is insulated from day3to3day political pressures1 his reflects the conviction held +oth the 4& and in many other countries that the people who control the country8s money supply should +e independent of the people who frame the government8s spending decisions1 Most studies of central +ank independence rank the !ed among the most independent in the world ,<orld =>01 "ach reserve +ank President is appointed to a five3year term +y that +ank8s Board of #irectors2 su+5ect to final approval +y the Board of ;overnors1 his procedure adds to independence2 +ecause the directors of each reserve +ank2 who are not political appointees2 provide a regional cross3section of interests2 including depository institutions2 nonfinancial +usinesses2 la+or2 and the pu+lic1 he !ed is structured to +e self3sufficient in the sense that it meets its operation e6penses primarily from the interest earnings on its portfolio of securities1 herefore2 it is independent of *ongressional decisions a+out funding1 "ven though the !ed is independent of *ongressional funding and administrative control2 it is ultimately accounta+le to *ongress and comes under government audit and review1 he *hairman2 other governors2 and $eserve Bank Presidents report regularly to the *ongress on monetary policy2 and a variety of other issues2 and meet with senior Administration officials to discuss the !ederal $eserve8s and the federal government8s economic programs ,<orld =?01 <ithin the !ed2 the !ederal 'pen Market *ommittee2 or !'M*2 has the primary responsi+ility for

conducting monetary policy1 he !'M* meets in <ashington eight times a year and has twelve mem+ers@ the seven mem+ers of the Board of ;overnors2 the President of the !ederal $eserve Bank of New (ork2 and four of the other $eserve Bank Presidents2 who serve in rotation1 he remaining $eserve Bank Presidents contri+ute to the committee8s discussions and deli+erations1 )n addition2 the directors of each $eserve Bank contri+ute to monetary policy +y making recommendations a+out the appropriate discount rate2 which are su+5ect to final approval +y the ;overnors1 he goals of 4& Monetary Policy according to the !ederal $eserve Act states that they are to promote ma6imum employment2 sta+le prices2 and moderate long3term interest rates1 he goals of monetary policy are inconsistent1 he +elief that a 4A unemployment rate and sta+le prices are inconsistent is shaped +y the widely accepted natural rate hypothesis1 )t argues that monetary policy has no effect on the economy8s long3run eBuili+rium unemployment rate2 which is often called the natural rate of unemployment1 he reason is that2 in the long run2 unemployment depends on so3called real factors such as technology and people8s preferences for saving2 risk2 and work effort7 these factors are +eyond the reach of monetary policy1 Most current estimates place the natural rate of unemployment in the range /1?/A and =1?/A1 *onsistent attempts to e6pand the economy +eyond its potential for production will result in higher and higher inflation2 while ultimately failing to produce lower average unemployment1 herefore2 most economists would argue that there are no long3term gains from consistently pursuing e6pansionary policies1 he crowding out of investment is traced to the failure of monetary policy ,"isner /901 Although there are some negatives with monetary policy2 it can determine the economy8s average rate of inflation in the long run1 hat is important for the economy2 +ecause high inflation can hinder economic growth in a couple of ways1 )t adds an inflation risk premium to long3term interest rates and it complicates the planning and contracting +y +usiness and la+or that are so essential to capital formation1 Cigh inflation also hinders economic growth in other ways1 !or e6ample2 +ecause the ta6 system isn8t inde6ed to inflation2 high inflation helps and hurts different sectors of the economy1 )n addition2 it makes people spend their time hedging against inflation instead of pursuing more productive activities1 Because the !ed can determine the economy8s average rate of inflation2 some commentators and some mem+ers of *ongress have emphasiDed the need to define the goals of monetary policy in terms of price sta+ility2 which is achieva+le1 But the !ed2 like most central +anks2 cares a+out +oth inflation and measures of the short3run performance of the economy1 Cowever2 pursuing multiple goals can create conflicts for policy1 'ne kind of conflict involves deciding which goal should take precedence at any point in time1 Another kind of conflict is the potential for pressure from the political arena1 he !ed is somewhat insulated from the pressure of politics +y its independence2 which allows it to achieve a more appropriate +alance +etween short3run and long3run o+5ectives1 he !ed will not use monetary policy to help a region in a recession1 'ften enough2 some state or region is going through a recession of its own while the national economy is prosperous1 But the !ed can not concentrate its efforts to e6pand the weak region for two reasons1 !irst2 monetary policy works through credit markets2 and since credit markets are linked nationally2 the !ed simply has no way to direct stimulus to any particular part of the country that needs help1 &econd2 if the !ed stimulated whenever any state had economic hard times2 it would +e stimulation much of the time2 and this would mean higher inflation1 he !ed can not control inflation or unemployment directly7 instead2 it influences them indirectly2 mainly +y raising or lowering short3term interest rates1 he ma5or tools the !ed uses to affect interest rates are open market operations and the discount rate2 +oth of which work through the market for +ank reserves1 Banks and other depository institutions are legally reBuired to hold a specific amount of funds in reserves1 *urrently2 +anks must hold :3-.A of the funds they have in interest +earing and non interest +earing checking accounts as reserves1 he amount of reserves a +ank has to hold

changes daily1 <hen +anks need additional reserves on a short3term +asis2 it can +orrow them from other +anks that happen to have more reserves than they need1 hese loans take place in a private financial market called the federal funds market1 he interest rate on the overnight +orrowing or reserves is called the federal funds rate or simply the funds rate1 )t ad5usts to +alance the supply of and demand for reserves1 he interest rate is also used as an indicator of monetary policy and future economic growth ,&ims E/.01 he prime tool the !ed uses to affect the supply of reserves in the +anking system is open market operations1 his means the !ed +uys and sells government securities on the open market1 hese operations are conducted +y the !ed8s open market trading desk at the !ederal $eserve Bank of New (ork1 )f the !ed wants the funds rate to fall it +uys government securities from a +ank1 he !ed then pays for the securities +y increasing that +ank8s reserves1 As a result2 the +ank now has more reserves than it is reBuired to hold1 &o the +ank can lend these e6cess reserves to another +ank in the federal funds market1 hus2 the !ed8s open market purchase increases the supply of reserves to the +anking system2 and the funds rate falls1 <hen the !ed wants the rate to rise it does the reverse +y selling government securities1 he !ed gets the payment in reserves from +anks2 which lower the supply of reserves in the +anking system2 and funds rate rises ,&egalstad -01 Banks also +orrow reserves from the !ed at their discount windows2 and in that case the interest rate they must pay on this +orrowing is called the discount rate1 he total Buantity of discount window +orrowing is called the discount rate ,<orld =>01 he discount rate plays a role in monetary policy +ecause2 traditionally2 changes in the rate may have signaled to markets a significant change in monetary policy1 A higher discount rate can +e used to indicate a more restrictive policy2 while a lower rate may signal a more e6pansionary policy1 herefore2 discount rate changes are sometimes coordinated with !'M* decisions to change the funds rate ,$ukeyser --401 A final tool of monetary policy are foreign currency operations1 Purchases and sales of foreign currency +y the !ed are directed +y the !'M*2 acting in cooperation with the reasury2 which has overall responsi+ility for these operations1 he !ed does not have targets2 or desired levels2 for the e6change rate1 )nstead2 !ed intervention aims to counter disorderly movements in foreign e6change markets1 )ntervention operations involving dollars2 whether initiated +y the !ed2 the reasury2 or +y a foreign authority2 are not allowed to alter the supply of +ank reserves or the funds rate1 he process of keeping intervention from affecting reserves and the funds rate is called the steriliDation of e6change market operations1 hese are not used as a tool of monetary policy1 he Point of implementing policy through raising or lowering interest rates is to affect people8s and firm8s demand for goods and services1 !or the most part2 the demand for goods and services is not related to the market interest rates Buoted on the financial pages of newspaper2 known as nominal rates1 )nstead2 it is related to real interest ratesFnominal interest rates minus the e6pected rate of inflation1 Monetary policy can affect real interest rates in the short run1 *hanges in real interest rates affect the pu+lic8s demand for goods and services mainly +y altering four things@ +orrowing costs2 the availa+ility of +ank loans2 wealth of households and +usinesses2 and foreign e6change rates1 %ower real rates and a healthy economy may increase +ank8s willingness to lend to +usinesses and households1 his may increase spending2 especially +y smaller +orrowers who have few sources of credit other than +anks1 %ower real rates make common stocks and other such investments more attractive than +onds another de+t instruments7 as a result2 common stock prices tend to rise1 Couseholds with stocks in their portfolios find that the value of their holdings has gone up2 and this increase in wealth makes them willing to spend more1 )n the short run2 lower real interest rates in the 4& also tend to reduce the foreign e6change value of the dollar2 which lowers the prices of the e6ports sold a+road and raises the prices of foreign produced goods1 "6pansionary monetary policy also raises aggregate spending on 4& produced goods and services +y improving the +alance of trade1 A monetary policy that constantly attempts to

keep short3term real rates low can lead to high inflation and higher nominal interest rates to protect the purchasing power of the funds due to them1 his is the reason that economic activity can not keep e6panding +eyond its potential level1 )nitially2 the low real interest rates will cause +usiness and households to increase their +orrowing demands2 and that will push up other longer3term interest rates1 hese tighter credit conditions will tend to cause real interest rates to rise despite the !ed8s attempts to keep them low2 there+y slowing economic activity2 moving it +ack toward its potential level ,"isner E/01 he precise magnitude and timing of the effects of the !ed8s actions on the economy are never perfectly predicta+le1 his is partially +ecause the future course of the economy is su+5ect to many influences +eyond the !ed8s control2 such as government ta6ing and spending policies2 the availa+ility of natural resources like oil2 economic developments a+road2 financial conditions at home and a+road2 and the introduction of new technologies1 )n addition2 human responses to economic incentives are inherently difficult to predict2 and may change over time2 leading to errors in predicting private aggregate spending ,$ukeyser -E401 Monetary policy alone cannot perform an economic miracle1 )t cannot eliminate all fluctuations of the +usiness cycle7 it cannot revitaliDe an outdated industrial machine7 it cannot reform and reduce an over+lown2 arrogant +ureaucracy7 +ut it can perform sta+iliDing functions crucial to the economy of the 4nited &tates of America1 Bibliography "isner2 $o+ert1 Cow $eal is the !ederal #eficit? New (ork2 he !ree Press2 -9>=1 !ederal $eserve &ystem1 <orld Book "ncyclopedia1 Vol1 ?2 =?3=>2 -9>>1 $ukeyser2 %ouis1 <hat8s Ahead for the "conomy@ he *hallenge and the *hange1 New (ork2 &imon and &chuster2 -9>:1 &egalstad2 "ric V1 #eterminants of the )nterest $ate1 'cto+er2 -99?1 &ims2 *12 *omparison of )nterwar and Post3<ar Business *ycles@ Monetarism $econsidered1 American "conomic $eview2 -9>.1 Bibliography "isner2 $o+ert1 Cow $eal is the !ederal #eficit? New (ork2 he !ree Press2 -9>=1 !ederal $eserve &ystem1 <orld Book "ncyclopedia1 Vol1 ?2 =?3=>2 -9>>1 $ukeyser2 %ouis1 <hat8s Ahead for the "conomy@ he *hallenge and the *hange1 New (ork2 &imon and &chuster2 -9>:1 &egalstad2 "ric V1 #eterminants of the )nterest $ate1 'cto+er2 -99?1 &ims2 *12 *omparison of )nterwar and Post3<ar Business *ycles@ Monetarism $econsidered1 American "conomic $eview2 -9>.1 <ords@ 44?>