Banking 16: Why target rates vs. money supply

The rationale for targeting interest rates instead of directly having a money supply target.

Category:

Education

Tags:

• money
• supply
• m0
• m1
• m2
• interest
• rate
• federal
• funds

[sgentry777]

Thanks. Extremely helpful.

In the context of the current crisis, the gov't appears to be doing contradictory things concurrently--(1) as you explain, BUYING Treasuries in the Open Market in order to 'lower FF rate' and thereby INCREASE money supply/liquidity while at same time (2) SELLING Treasuries (borrowing) in order to fund 'bailouts' , thereby DECREASING (or mopping up) liquidity. I'm confused.

[khanacademy]

They are both actually consistent actions with increasing the money supply. As long as inflation does not become an issue and the total government debt does not become unsustainable, the Treasury could issue more and more debt which essentially gets bought by the Fed with newly printed notes. This is the Fed's last tool to fight a deflationary spiral.

[jdrizd2]

Just because the expected return on an investment is low doesn't mean it is risky if it is a necessity, I believe that most supermarkets profit margin is low but they are high necessities. Other businesses are highly risky, i.e. airlines and automakers, yet can persuade banks and government to create loans. Why is there so much socialized baiilout for high risk businesses?

[khanacademy]

Those percentages aren't expected returns, they are the funding rates at which the projects would proceed. My point is that by focusing on rates, the "quality" threshold for projects stays constant. Also, low gross/operating margin at a retailer doesn't mean a low expected return on their investment (I'll eventually do a playlist on topics like that).

[khanacademy]

Just to hit the point home, let's say that you start with $.99 that you use to buy an apple which you sell for 1.00 (so .01 gross profit or 1% gross margin). You can then use the 1.00 to by another apple and repeat. If you do this 100 times in a year, you will make upwards of $1.00 (since you can reinvest the profit) on a .99 initial investment. That is a 100% return on investment despite only making a 1% margin on each transaction.

[dpod916]

the reason is because the person who wants to borrow the money will only be willing to borrow at a certain rate...if your project will yield a 30% return on investment then you would be willing to pay 20% in interest where as if you will only receive 5 percent return then you would not be willing to accept any rate of interest above 4 percent because then you would be either breaking even or losing money. it is the assessment of risk by the borrower not the lender in this instance.

[michaelfresco]

The FED has an extremely difficult task to forecast the expected return on the projects undertaking by 305 million citizens.

I believe that a free banking sytem, where there is not a single planning agency (FED) to project the required M1,M2 is a much better system. The current system is doomed to fail every 4 or 5 decades.

Reference

For more Google: Econtalk Selgin on Freebanking

[qm1qm1]

To be honest, I didn't watch your video. What you say could be the explanation I gave. But if you need 12 minutes to describe your explanation, something's wrong with either your understanding or teaching technique.

[qm1qm1]

The reason: the broad money supply is determined endogenously. There is a clear answer

Explanation: to use the language that you learned in an undergrad course, the "multiplier" is not some fixed value, but it depends on the voluntary actions of people in the economy. In a downturn, there will be a low "multiplier", so even if banks got an significant boost in reserves, banks don't want to lend and consumers and businesses don't want to borrow, so we wouldn't get an increase in broad money.

[tangiblephoton]

ignored the phone coz he's on a roll lols....

[parenteaujason]

@tnekkc The assumption Kahn makes in that statement is that everbody acts logically, with data and statistics and margins of error and whatnot. Of course there are idiots out there who 'think' they have some great idea and would borrow at ridiculous high interest rates. Just watch an episode of "Dragon's Den" or "Shark Tank" (depending on where you're from) and you'll see all the idiots out there. Large corporations and succesful businesses generally won't make those mistakes.

[dadac123]

It made me to realize the demand and the supply again.

I always heard of demand and supply, but seldom actually use them in the reality.

But now I found that it is not the quality of something, but the demand and supply of something determined our most daily actions and decisions.

[IvanAndreevich]

And the government is supposed to know when the time for good projects is? LOOOL. Only the market knows that.

[cepson]

3 people were pissed he wouldn't answer their phone call.

[tnekkc]

Good projects are those willing to borrow at a higher rate?

I don't think so.

Kahn fail.