Imagine interest rates rising from 6 to 8 percent per year.
The price you can get for your bond will fall to $106/1.08 or $98.15.
A buyer would need only $98.15 to get the $106 next year.
The price of the bond fell as interest rates went up.
The present value of a future payment is lower at a higher interest rate.
Many types of bonds pay different sums of money at different times in the future.
All bonds promise to pay money in the future.
The same logic that applies to simple one period bonds, like the one just described, applies to more complex bonds.
As interest rates rise, investors need less money to meet the promised payments in the future, so the price of all these bonds falls.
As interest rates fall, investors need more money to make their payments.
Bond prices will move in the opposite direction of interest rates when the Fed changes interest rates.
Interest rates fall when the Federal Reserve buys bonds.
Think about what the Federal Reserve is doing when it conducts an open market purchase.
The Federal Reserve is buying bonds.
The demand for bonds increases when the Fed buys them.
As interest rates fall, bond prices rise.
An open market sale of bonds by the Fed increases interest rates.
An open market sale by the Fed increases the supply of bonds in the market.
The price of bonds will fall if the supply of bonds increases.
Because the Federal Reserve can change interest rates with open market purchases and sales and thus affect the price of bonds, Wall Street firms hire Fed watchers to try to predict what the Fed will do.
If a Wall Street firm correctly predicts that the Fed will surprise the market and lower interest rates, it could buy millions of dollars of bonds for itself or its clients and make huge profits as the prices of the bonds inevitably rise.
You may have heard on television or read in the newspaper that prices in the bond market often fall in the face of good economic news.
The bond market can be understood by thinking about the demand for money.
Demand for money will increase when GDP increases.
The money demand curve will shift to the right as demand for money increases.
Increased money demand will increase inter est rates.
Bond prices move in opposite directions.
Good news for the economy is bad news for the bond market.
If the rise were temporary, waiting too long to change policy would be costly.
The results of the experiment showed that committees make decisions more quickly than individuals do.
Blinder found that it did not matter if the committee had a strong leader.
Professor Alan Blinder came back to teaching after serving as the Federal Reserve's vice-chairman from 1994 to 1996.
The leader was convinced that committees were not effective for mak power, and that the committee functions more like an individual decision about monetary policy.
Blinder wanted to know if Exercise 5.9 was individu.
If unemployment were to go up in a single month, experiment.
The National Bureau of Economic Research thinks it could be a temporary blip.
Learning objective is to describe both the domestic and international channels through which higher or lower interest rates are just a means to an end.
Real GDP can be affected by monetary policy.
Fed's ultimate goal is either to slow or speed the economy by influencing aggregate demand.
To show how the Fed affects the interest rate, which in turn affects investment, and finally GDP itself, we combine our demand and supply for money with the curve that shows how investment spending is related to interest rates.
It is the same as Figure 14 on page 326.
The equilibrium interest rate for money is shown in the graph.
Consumption and investment can be affected by interest rates.
Spending on consumer durables, such as automobiles and refrigerators, will depend on the rate of interest.
If you buy an automobile, you will incur the cost today and receive benefits in the future, such as the ability to use the car in the future.
The opportunity costs of investing in an automobile will rise as interest rates rise.
The increase in opportunity cost will cause consumers to purchase fewer cars.
Changes in interest rates affect investment, but the purchases of consumer durables are also affected.
The money market is where it is determined.
The increase in investment spending will shift the aggregate demand curve to the right.
Reducing interest rates affects output and prices in the economy.
When the Fed increases the money supply, it leads to lower interest rates and increased investment spending.
A higher level of investment spending will lead to a higher level of GDP.
The Fed can use its influence to increase interest rates, which will have the opposite effect.
Aggregate demand will fall along with investment spending.
The price level and output in the economy will fall as the aggregate demand curve shifts to the left.
We have not taken into account international trade or international movements of financial funds when discussing monetary policy.
Monetary policy will operate through an addi tional route once we bring in these considerations.
Suppose the Federal Reserve buys bonds in the open market.
As a result, investors in the United States will be earning lower interest rates and will look to invest some of their funds abroad.
To invest abroad, they will need to sell their U.S. dollars and buy foreign currency.
The exchange rate will fall because of the price at which currencies trade.
The lower the dollar's value, the cheaper U.S. goods will be on world markets.
If the exchange rate is two Swiss Francs to the dollar, you will receive two Swiss Francs for every dollar you exchange.
It will cost 200,000 Swiss Francs to buy a U.S. machine.
Suppose the dollar's value goes down so that one dollar buys one Swiss Franc.
Swiss residents will pay half of what they used to pay for the same machine in the U.S.
The lower the dollar is, the cheaper U.S. goods are for foreigners.
Foreign residents will want to buy more U.S. goods and U.S. companies will want to export more goods.
The lower value of the U.S. dollar is good news.
The good news is that it will be more expensive to buy foreign goods in the U.S. because of the lower value of the dollar.
Swiss chemicals with a price tag of 60,000 Swiss Francs would cost $30,000 in the U.S. if the exchange rate were still two Swiss Francs to the dollar.
The same chemicals will cost twice as much if the dollar's exchange rate goes down.
U.S. residents tend to import less when the dollar depreciates.
As the exchange rate for the U.S. dollar falls, U.S. goods become cheaper and foreign goods become more expensive.
The demand for U.S. goods increases as a result of this increase in net exports.
The money supply increased because of an open market purchase of bonds by the Fed.
Interest rates, exchange rates, and net exports are the new links in the sequence.
The sequence works in reverse.
If the Fed sells bonds in the open market, interest rates will go up.
Foreign investors who earn lower interest rates elsewhere will want to move their money to the United States where they can earn a higher return.
The dollar will increase in value as they buy more U.S. dollars.
Suppose the U.S. is a country.
The machine the Swiss had to pay 200,000 Francs for when the exchange rate was one dollar to two Francs is now 300,000 Francs.
When the U.S. interest rates rise as a result of an open market sale by the Fed, we expect exports to decrease and imports to increase.
The fall in output will be caused by the decrease in net exports.
Investment spend ing and net exports will be reduced by an increase in interest rates.
Investment spending and net exports will be increased by a decrease in interest rates.
Monetary policy in an open economy is more powerful than monetary policy in a closed economy.
The power of exchange rates and international trade is something the Fed and other central banks are aware of.
The effects of monetary policy on exchange rates are critical to the economic well-being of countries that depend heavily on inter national trade.
Assess the challenges the Fed faces in implementing monetary policy after seeing how changes in the money supply affect aggregate demand.
If the current level of GDP is below full employment or potential output, the government can use expansionary policies such as tax cuts, increased spending, or increases in the money supply to raise the level of GDP and reduce unemployment.
The rate of inflation will increase if the current level of GDP surpasses full employment or potential output.
The government can use contractionary policies to reduce GDP back to full employment.
Some of the limitations of stabilization policy were explored earlier.
Fiscal policy is subject to lags because political parties have different ideas about what the government should or should not do, and it takes them time to reach agreement.
Monetary policy has its own problems.
There are two types of lags in policy.
The lags for monetary policy are shorter than those for fiscal policy.
Major policy changes can be made at any time when the committee meets eight times a year.
The chairperson of the Board of Governors can make changes between meetings.
It takes time for the people working at the Fed to realize that there are problems in the economy.
The 1990s is a good example.
Iraq invaded Kuwait in 1990.
The United States is heavily dependent on oil and there was concern that higher oil prices and the uncertainty of the political situation in Kuwait would cause a recession.
In October 1990 Greenspan testified before Congress that the economy had not yet entered a recession.
Greenspan declared that the economy had entered a recession in December.
We now know that the recession started in July.
The lags related to monetary policy are long.
It will take at least 2 years for most of the effects of an interest rate cut to be felt.
The Fed can't predict when a recession will occur.
In May 2000 the Fed raised the federal funds rate because they were worried about inflation.
The rate was restored on January 3, 2001 because the Fed feared a recession.
It wasn't enough to prevent the 2001 recession.
The Fed did not believe that the problems in the housing market would spill over to the financial sector.
The economy was stable at 9:02 PM.
The Fed should keep the inflation rate low and stable.
Monetary policy is made by a committee.
The Fed controls only short-term interest rates in the economy, not long-term interest rates, through its traditional open market policies.
Once the Fed decides what it wants in the market, it opens market operations to achieve this rate.
The Federal Reserve sets a short-term interest rate for the economy when it decides monetary policy.
When a firm is deciding on a long-term investment or a household is deciding whether to purchase a new home, it will base its decisions on the interest rate at which it can borrow money, not a short-term rate.
A household could take out a 30-year mortgage to buy a home.
It might not take out the loan if the rate is too high.
For the Fed to control investment spending, it must also influence long-term rates.
It can influence short-term rates.
Averages of current and expected future short-term interest rates are known as long-term interest rates.
If you want to see why future short-term interest rates are so high, put $100 in the bank for 2 years.
If the interest rate is 5 percent for the first year, you would have $105 at the end of the year.
At the end of the second year, if the interest rate was 10 percent, you would have $115.50.
The present value of payments in the future on a bond or loan is determined by both the current short-term interest rate and future short-term rates.
Long-term interest rates are an average of the current short-term interest rate and expected future short-term rates.
The federal funds rate can be controlled by the Fed.
Information to the market about the likely course for future short-term rates is provided by its actions.
The public needs to be convinced that the Fed will keep future short-term rates low in order to reduce long-term interest rates.
Influencing expectations of the financial markets is an important part of the Fed's job.
The Fed tries to communicate its intentions to the public in order to make policies more effective.
The public needs to form its own expectations of what the Fed will do.
Financial market expectations make it difficult for the Fed to develop monetary policy.
The Fed debated how to communicate with the financial markets.
The public's expectations of the Fed's future policies in the financial markets can be monitored.
Market participants place bets on future federal funds rates in the "futures" markets.
The Fed can see what the market is thinking before taking any action on interest rates.
The Fed has to decide whether to take actions that are in line with market expectations or to surprise the market.
Several steps have been taken by the Fed to better control expectations about long-term interest rates.
Quantitative easing is the policy of buying and selling long-term bonds.
The Fed wanted to gain more control over long-term interest rates by directly intervening in the long-term bond market.
The Federal Reserve asked the members of the Federal Open Market Committee for their predictions of short-term interest rates in the future and to make them public.
The markets know what the current members of the FOMC think about monetary policy because they make their predic tions public.
The chapter showed institutions.
The Fed uses open market operations to implement monetary policy.
The Federal Reserve buys bonds together to increase GDP.
The Federal for money by the pub Reserve sells bonds on the open market to decrease GDP.
Interest rates affect exchange 6.
In an open economy, a decrease in interest rates will lead to a decrease in net exports.
There are limits to what effective monetary can do to increase net exports.
An increase in interest rates will appreciate the local 1.
The interest rate currency affects the demand for money and leads to a decrease in net exports.
There is a need to influence mar 2.
All the problems are assignable in MyLab Economics.
Banks borrow from the Fed.
The interest rates on the reserves are being raised.
As prices increase, the demand for U.S. dollars in China should increase.
The Chinese raised the reserve transactions based on individual desire.
Checking account interest rates can be high.
A ance sheet can be shown through purchases of assets.
The ATM is next to the apartment building.
The Fed can determine short-term interest rates using supply and demand curves.
You can only withdraw funds from your real income at the ATM.
People to something.
This is an example of the demand for money.
Rise in bond prices and interest rates are caused by open market purchases.
A bond is priced.
The Fed should raise interest rates to increase the supply of money.
The economy creates demand.
Banks trade reserves in the market to see what happens to interest rates.
The stock market is policy, not monetary policy.
Long-term interest rates are directly controlled by the Fed.
The effects of monetary policy through interest rates, exchange rates, and net exports are more rapid than the effects of monetary policy on investment.
Monetary policy can affect GDP.
The price of bonds have been looked at by central bankers.
If stock prices start to rise, the Fed should use that to signal an open market for bonds.
The interest rate on a 1-year bond will be less than the supply for money.
What is the value of a country's currency?
In an open Web page of the Federal Reserve where they have economy, changes in monetary policy affect both the speeches and est rates.
The United States and the United Kingdom are both given by Fed officials.
The tradition of a strong chairman in the United States reduces the Monetary Policy Challenges for the Fed.