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Economics 435The Financial System
(11/9/2015)
Instructor: Prof. Menzie ChinnUW MadisonFall 2015
Outline
• What is the Fed? What is the ECB?• IS‐LM: Textbook monetary policy (pre‐2008)• IS‐LM: monetary policy in practice (pre‐2008)• Where does a central bank fit in the economy?
• Taylor Rules
12‐3Source: Mishkin
Federal Reserve System:Organization
Federal Reserve System:Regional Distribution
16‐5
Comparing Organizational Structure
Federal Reserve Banks =>
Board of Governors ===>
FOMC ============= >
16‐6
Textbook Monetary Policy (pre‐2008)
Monetary Policy in Practice (pre‐2008)
Central Banks in the Financial System
17‐10
The Central Bank’s Balance SheetOpen Market Operations
17‐11
Foreign Exchange Intervention,Cash Withdrawal
17‐12
Deposit Creation
17‐13
17‐14
The Limits on the Central Bank’s Ability to Control the Quantity of Money
17‐15
• In the 1930s the Fed saw its balance sheet growing.
• Officials did not realize that the money multiplier was falling.
• Without knowing it, the Fed ran a contractionarypolicy during the Depression.
18‐16
The Fed’s Conventional Policy Toolbox
18‐17
The Target Fed Funds Rate & Open Mkt. Ops.
18‐18
The Target Fed Funds Rate
18‐19
The Target Fed Funds Rate w/Channel System
18‐20
ECB Hitting Target Refi Rate
Taylor Rules
• Positive statement? Is this how central banks behave?
• Or normative statement? Is this how central banks should behave?
Source: St. Louis Fed, https://research.stlouisfed.org/datatrends/mt/page10.php
FRB St. Louis Interpretation of the Taylor Rule
FRB SF Interpretation of the Taylor Rule
“Your Name Here” Interpretation of the Taylor Rule
Bloomberg Financial Conditions Watch (Dec. 12, 2012)
Issues (within the framework)• Which activity variable (output, unemployment)?
• Which inflation measure (CPI, PCE deflator, or respective core measures; 12 month, 3 month, etc.)
• What is the “natural” rate of real interest rate?• Should it be forecasted output and inflation that matters?
• How to deal with data revisions?
Using Forecasted Values of y, π
Source: Orphanides and Wieland (2007)
The Impact of Data Revisions
Source: Molodtsova, et al. (JME 2008). http://www.uh.edu/class/economics/news‐research/working‐papers/docs/2007‐03.pdf
Revisions in 2001‐03
9,600
9,800
10,000
10,200
10,400
10,600
10,800
11,000
2000 2001 2002 2003 2004
GDP,bn.Ch.00$
03Q33rd rel.
09Q13rd rel.
Taylor Rules and Inflation Targeting
• Question of interpretation: Why does the output gap enter? Is it determinant of future inflation (via Phillips Curve)? If so, Taylor rule is inflation targeting.
• More explicit: Set β=0, δ=1.
