from 10 percent to 8 percent, for example, decreases the monthly payment on a 30-year mortgage by more than 16 percent. This saving markedly increases the demand for residential construction. The export- and import-competing sectors are also strongly affected. Interest-rate changes cause foreigners to change their demand for our currency to invest in our financial assets, altering the exchange rate and affecting the profitability of business in the international sector.
Our discussion of monetary policy is not yet complete. The next chapter examines its role in an inflationary environment, providing further insight into the relationship between monetary policy and interest rates. Chapter 16 looks at how monetary policy is affected by international influences.
Media Illustrations
Example 1
The average yield at this week's auction of $17.8 billion of 91-day Treasury bills was 11.17 percent, up from 10.95 percent last week. Accepted bids for the bills ranged from a high of $97.300 for an 11.13 percent yield to a low of $97.288 for an 11.18 percent yield. The average bid price was $97.290.
Has the average bid price risen or fallen from what it was last week?
The yield, or interest rate, has risen from last week to this week. The price must have fallen to produce this rise in yield.
How would one calculate that a bid of $97.300 corresponds to a yield of 11.13 percent?
A 91-day T-bill bought now for $97.30 will be worth $100.00 in 91 days when it matures, so its return over 91 days is (100 - 97.30)/97.30. To find the corresponding annual yield we must convert the return over 91 days to a return over 365 days by multiplying by 365/91, obtaining 11.13.
Example 2
Some economists criticized the central bank for not moving in the face of the waning recovery. One, who prefers anonymity, stated: "The failure to move today leaves us with low inflation, a weak economy and climbing jobless claims; these are classic signs of an impending downturn. The Fed fiddles while the economy burns."
What kind of movement would this economist want to see?
He must feel that there is little danger of an expansionary monetary policy creating inflation and would argue that a discretionary increase in the money supply, or, equivalently, a fall in interest rates, is in order.
Why might the Fed not move?
The Fed may not yet feel that the economy is definitely entering a recession often early numbers are revised, and often what appears to be the beginning of a recession is no more
