Monetary and fiscal policy switching.

Two THEMES RUN through policy analysis: rules determining policy choice are functions of economic conditions; those rules may change over time. The themes reflect the views that actual policy behavior is purposeful, rather than arbitrary, and that good policy adapts to changes in the structure of the economy or to improvements in understanding how policy affects the economy.

A growing body of evidence finds that policy reaction functions vary substantially over different periods in the United States. In light of this evidence of regime shifts, which is reviewed in Section 1, it is surprising that there is little formal modeling of environments where ongoing regime change is stochastic, and the objects subject to change are parameters determining how the economy feeds back to policy choice.

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Monetary policy and the term structure of interest rates in Japan.

This paper is investigates the relationship between the Japanese yield curve and monetary policy. In the 1980s and 1990s average bond yields have risen from 5% to 8% and then fallen to 2% and the slope of the yield curve has swung from positive to negative to positive. We are interested in understanding the contribution of monetary policy to these movements in the yield curve.

One motivation for our interest is Japan’s recent experience. In spite of massive increases in monetary base and a zero nominal interest rate, economic growth has remained low and deflationary pressure has not abated. These events are raising new questions about the effectiveness of monetary policy under a zero nominal interest rate policy. Eggertson and Woodford (2003) argue that a monetary authority can still influence economic activity when nominal interest rates are zero by taking actions that affect market expectations about the future time path of variables such as interest rates, inflation or exchange rates. One way to assess the ability of a central bank to affect expectations is to look retrospectively and ascertain the extent to which previous monetary policy surprises have affected bond yields of different maturities. If monetary policy is indeed a potent tool for altering expectations then this should show up in the responses and variance decompositions of medium and long-term bonds yields to suitably identified shocks to monetary policy.

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Bond Fundamentals – Monetary Policy and Fiscal Policy

It’s the Federal Reserve Bank that influences the money supply. Three tools are used to implement monetary policy:

  1. Open Market Operations
  2. Discount Rates
  3. Reserve Requirements

Since open market operations is the tool used most, we will cover it. Here’s how it works: When the economy is growing too fast and the Fed is worried about the inflation rate, it will sell government securities from its portfolio to the open market. This decreases bank reserves, which means the money supply decreases. When there are less bank and businesses have to pay the bank more in order to borrow. This discourages consumers and businesses from borrowing. Less borrowing means less spending, which slows the economy and eventually can reduce price pressures.

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