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.

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.stlouisfed.org/ Click on Research & Data in the row near the top then on Economic Data-FRED then on Categories. Under Money Banking & Finance, click on Monetary Data. Click on M2 and Components. M2 contains all the components of M1 (Cash, checkable deposits and travelers' checks) plus some additional items.

Questions for Part I

1. 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 seasonally adjusted and 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. Describe what they are.

Now under the first M2 Money Stock link, check the box for Monthly, Not Seasonally Adjusted and then click on that link. Click on View Data beside the chart. Scroll down to the latest value.

2. What is the latest value for M2? How much has it changed over the last 10 years?

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 in the top panel. Click on Federal Open Market Committee and then on Meetings calendars and information. Click on the latest Statement link on the calendar. Print the page to include in your report. Click the back arrow. Scroll down and click on the Statement link for the previous meeting (the one before the one you printed. 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 back to the St. Louis site. Click on Research... then on FRED... Click on Categories then on Interest Rates. Click on FRB Rates...then under Effective Federal Funds Rate check Weekly and then click on the link. Click on 1yr at the top of the chart, then print it.

Questions for Part III

1. 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?

Finally, click the Back button on your browser 2 times to return to the Interest Rate Data section. Click on Treasury Bills then under the 3-Month Treasury Bill Rate, Secondary Market heading, check Weekly then click on the link. Select1yr as above. Print the graph.

2. Is there any evidence that Fed policy can affect interest rates other than the Fed Funds Rate? Explain.