AP Macroeconomics AMSCO Guided Notes
4.6: Monetary Policy
AP Macroeconomics Guided Notes
AMSCO 4.6 - Monetary Policy
Essential Questions
- What are the short-run effects of monetary policy on macroeconomic outcomes?
I. What Is Monetary Policy?
1. What is monetary policy and what are the three major objectives of monetary policy?
A. What Is a Central Bank?
1. What is a central bank and what are its primary functions?
2. How does monetary policy indirectly affect longer-term interest rates, currency exchange rates, and asset prices?
3. What aspects of the economy does monetary policy ultimately influence?
II. Monetary Policy Frameworks
1. What are the two main frameworks that determine how central banks implement monetary policy?
A. Limited Reserves Framework
1. How does a limited reserves framework work and why must banks maintain reserve requirements?
2. What was the Federal Reserve's primary tool for influencing the federal funds rate before the Great Recession?
1. Tools of a Limited Reserves Framework
a. Open-Market Operations
1. What are open-market operations and how do they affect the money supply and economic activity?
2. How do open-market purchases and open-market sales differ in their effects on bank reserves and lending?
b. Reserve Requirements
1. What is the reserve requirement and how do changes to it affect the money supply and lending?
2. How can the central bank use reserve requirements to combat inflation during expansion and stimulate the economy during recession?
c. Discount Rate
1. What is the discount rate and how does changing it affect borrowing and the money supply?
B. Ample Reserves Framework
1. What is an ample reserves framework and how does it differ from a limited reserves framework?
2. What are the advantages of an ample reserves framework for the Federal Reserve and financial stability?
3. What is the federal funds rate and why does the Federal Reserve target it as its primary policy rate?
1. Tools of an Ample Reserves Framework
1. What are the two main administered rates the Federal Reserve uses to implement monetary policy in an ample reserves framework?
2. How does the interest on reserve balances (IORB) affect banks' decisions to lend or hold reserves?
3. How do changes in administered rates influence the federal funds rate and interest-sensitive spending?
4. What is the relationship between the discount rate and IORB, and why is the reservation rate important?
III. The Effects of Monetary Policy
1. How does monetary policy influence the economy in the short run?
A. Contractionary Monetary Policy
1. What is contractionary monetary policy and when do central banks use it?
2. What tools can central banks use to implement contractionary monetary policy in an ample reserves framework?
3. What tools can central banks use to implement contractionary monetary policy in a limited reserves framework?
4. How does contractionary monetary policy affect interest rates, aggregate demand, price level, and real GDP?
B. Expansionary Monetary Policy
1. What is expansionary monetary policy and what are its goals?
2. What are recognition lag and impact lag, and why do they affect the timing of expansionary policy?
3. What tools can central banks use to implement expansionary monetary policy in an ample reserves framework?
4. What tools can central banks use to implement expansionary monetary policy in a limited reserves framework?
5. How does expansionary monetary policy affect interest rates, aggregate demand, price level, and real GDP?
IV. Monetary Policy Limitations
A. Forecasting and Timing Difficulties
1. Why is it difficult for central banks to determine the appropriate magnitude of changes to interest rates or money supply?
B. The Business Cycle
1. Why is monetary policy least effective at either end of the business cycle?
C. The Global Economy
1. How does globalization and foreign-held U.S. dollars limit the central bank's ability to regulate the economy?
Key Terms
monetary policy
central bank
limited reserves framework
ample reserves framework
open-market operations
reserve requirement
discount rate
administered rates
federal funds rate
interest on reserve balances (IORB)
policy rate
expansionary monetary policy
contractionary monetary policy