Monetary Policy

• Module 36: The Federal Reserve and Monetary Policy
• Module 37: The Money Market
• Module 38: Monetary Policy and the Interest Rate
• Module 39: Money, Output, and Prices in the Long Run

PERSON OF THE YEAR

“A bald man with a gray beard and tired eyes is sitting in his oversize Washington office, talking about the economy. He doesn’t have a commanding presence. He isn’t a mesmerizing speaker. He has none of the look-at-me swagger or listen-to-me charisma so common among men with oversize Washington offices. His arguments aren’t partisan or ideological; they’re methodical, grounded in data and the latest academic literature. When he doesn’t know something, he doesn’t bluster or bluff. He’s professorial, which makes sense, because he spent most of his career as a professor.”

So began Time magazine’s profile of Ben Bernanke, whom the magazine named Person of the Year for 2009. Who is this mild-mannered man, and why did he matter so much? The answer is that Bernanke was chairman of the Board of Governors of the Federal Reserve System—the body that controls monetary policy. In 2014, Bernanke was succeeded in the post by Janet Yellen.

People sometimes say that the Fed chair decides how much money to print. That’s not quite true: for one thing, the Fed doesn’t literally print money, and beyond that, monetary decisions are actually made by a committee rather than by one person. But, as we will see, the Federal Reserve can use open-market operations and other actions, such as changes in reserve requirements, to alter the money supply—and, like others who held the job of Fed chair, Ben Bernanke had more influence over these actions than anyone else in America.

And these actions matter a lot. Roughly half of the recessions the United States has experienced since World War II can be attributed, at least in part, to the decisions of the Federal Reserve to tighten policy to fight inflation.

In a number of other cases, the Fed has played a key role in fighting slumps and promoting recovery. The financial crisis of 2008 put the Fed at center stage. Bernanke’s aggressive response to the crisis included a tripling of the monetary base, inspiring both praise (including his designation as Person of the Year) and condemnation.

In this section we’ll learn how monetary policy works—how the Fed’s actions can have a powerful effect on the economy. We’ll start by looking at what the Federal Reserve does and the tools it uses. We’ll proceed to consider the demand for money from households and firms. And then we’ll see how the Fed’s ability to change the supply of money allows it to move interest rates in the short run and thereby affect real GDP. We conclude by examining U.S. monetary policy and its long-run effects.