Federal Reserve Monetary Policy Case

Introduction

In class, we found that the Fed is responsible for establishing and implementing monetary policy in the U.S. It does this by using its three major policy tools, open market operations to change the Federal Funds rate, reserve requirement changes, and discount rate changes, to bring about favorable changes in the economy.

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The main policy-making body in the Fed is the Federal Open Market Committee (FOMC). Your task in this assignment is to review recent monetary policy decisions undertaken by the FOMC and to write a brief report where you answer the questions shown below.

Instructions to Part I: The Supply of Money

First, look at what the Fed ultimately attempts to control with its policy actions: the supply of money, as measured by M2. Generally, the faster the money supply grows, the faster the economy grows and vice-versa.

Go to the Federal Reserve of St. Louis’s Web site http://www.stls.frb.org Click on RESEARCH & Data in the row near the top. Then click on FRED Economic Data. Under Category Click on Monetary Data under Money, Banking, & Finance section M2 and Components. M2 contains all the components of Ml (Cash, checkable deposits and travelers’ checks) plus some additional items.

Questions for Part I

  • The list on the screen identifies the items that are added to M1 to get M2. (The items are repeated for different dates and for SA and NSA. SA stands for seasonally adjusted, NSA stands for not seasonally adjusted. Also, some of the items are totals of some of the others.) List 2 of these items that are included in M2.
  • What is the latest value for M2? How much has it changed over the last 10 years?

Now click on M2 Monthly Money Stock (NSA) link. Download the data into an Excel document. Scroll down to the latest value.

Instructions to Part II: FOMC Policy Decisions

The FOMC meets on a regular basis to decide what actions they wish to take. Many times, they decide to do nothing, but other times they wish to either slow down the economy or speed it up.

To find out what the FOMC has recently done, go to the main Fed Web site at http://www.federalreserve.gov and click on Monetary Policy. Under the Federal Open Market Committee section click on the FOMC Calendar. Click on the most recent Statement link on the calendar. Print the page to include in your report. Also open the document for the meeting prior to the most recent meeting, bearing in mind that you may need to go to the previous year. Print this page to include in your report.

Question for Part II

1. Describe the actions taken (if any) by the FOMC as reported in each statement. Explain the reasoning behind the FOMC’ s actions (or lack thereof) as reported in each statement. What effects do you think the FOMC’s policy decisions will have on M2?

Instructions for Part III: Monetary Policy and the Fed Funds Rate

Almost always when the FOMC makes a policy change, it attempts to either increase or decrease the Fed Funds rate. An increase raises the cost of bank funds which leads to a reduction in lending and, ultimately, the money supply. In addition, an increase in the Fed Funds rate usually leads to an increase in other interest rates. The effect is to slow down the economy to reduce the threat of inflation. Exactly the opposite occurs when the Fed lowers the Fed Funds rate.

To check on recent changes in the Fed Funds Rate go to stloiusfed.org Under Research & Data click on FRED Economic Data next click on Category and then under Money, Banking & Finance click on Interest Rates and then FRB Rates – discount, fed funds, primary credit under Effective Federal Funds Rate click on the Monthly Link (Percent, Not Seasonally Adjusted). Print this chart and submit with case.

Questions for Part III

  • The Fed Funds rate should reflect the recent FOMC policy actions you discovered earlier (either up, down or steady). What does the chart tell you about past FOMC monetary policy decisions during the time period shown?
  • Is there any evidence that Fed policy can affect interest rates other than the Fed Funds Rate? Explain.

Finally, click the Back button on your browser twice to return to the U.S. Monthly Interest Rate Data section. Scroll down to the 3-Month Treasury Bill Rate, Secondary Market link and click on it. Bring up a gif chart as you did with the Fed Funds rate. Right click on it and either print it or save it to include in your report.

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