FIN 4520 - SUPPLEMENT TO CHAPTER 24 (MONETARY POLICY)

Criteria for choosing targets:

Measureable

Controllable

Predictable effect on goals

Operating target: fed funds rate and reserve aggregates both satisfy the first two criteria as operating targets. Choice of intermediate target determines which operating target better meets the third criterion.

Interest rates make better targets than monetary aggregates when shocks to money demand dominate shocks to spending.

Four types of uncertainty facing Fed's change of interest rates:

1. Market reactions (bonds, stocks, foreign exchange, credit)*

2. Real aggregate demand reactions*

3. Unemployment reaction

4. Inflation reaction (to change in unemployment)

*the more important.

Assessing the tradeoffs between employment and inflation:

Natural rate of unemployment: clearer in U.S. than in most countries.

Price stability "is" when people don't talk about inflation or plan around it.

Recent technique of "opportunistic disinflation."

Challenges / issues in the process:

Danger that the Fed may react too much to markets, creating a short-run perspective.

Decision by committee, unlike Canada and Italy.