Federal Reserve and Monetary Policy Quiz

Federal Reserve and Monetary Policy

• The primary mandate of the Federal Reserve (Fed) is to maintain price stability and maximize sustainable employment.
• The Taylor rule uses the inflation rate and output gap to determine the Fed funds target rate.

Monetary Policy Tools

• R-star is the equilibrium real rate of interest consistent with an economy at full potential.
• A decrease in the central bank's key interest rate decreases the yield on longer-dated maturities.
• An expansive monetary policy implies an increase in the money supply.
• Quantitative easing (QE) is a tool used in unconventional monetary policy.

FED Model

• The primary purpose of the FED model is to compare bond yields with earnings yields of S&P500.
• The main components of the FED model are the 10-year Treasury yield and earnings yield of S&P500.

Inflation

• A source of higher inflation mentioned in the session is supply-side shocks.
• During the COVID-19 pandemic, Phase I of higher inflation occurred due to supply-side shocks.
• A potential consequence of wage increases during inflationary periods is a decrease in purchasing power.
• A decrease in the money supply decreases inflation.
• Wage increases exceeding inflation could potentially lead to a wage-price spiral in the economy.

Yield Curve and Monetary Policy

• A steepening yield curve typically relates to an expansionary monetary policy.
• The Federal Reserve primarily influences long-term interest rates through forward guidance and quantitative easing.
• The purpose of quantitative easing (QE) as a monetary policy tool is to reduce long-term interest rates.
• A flat or inverted yield curve typically discourages banks from lending.

Business Cycle

• The expansion phase is typically characterized by high levels of consumer confidence and increased spending.