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Chapter15 monetarytheory-and-policy-140831163822-phpapp02

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Siphokazi Mavuso
Siphokazi Mavuso

This document discusses monetary theory and policy. It covers the demand for money, how the Federal Reserve controls the money supply through tools like reserve requirements and open market operations, and how changes in the money supply can affect interest rates, investment, aggregate demand, inflation, and economic output. The quantity theory of money and equation of exchange are introduced, as well as the monetarist view that changes in the money supply directly impact prices and economic activity. The document also discusses the Federal Reserve's historical approach to targeting money supply growth versus interest rates.

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Chapter 15 Monetary Theory and Policy
Why would people hold money? Transactions Demand for Money Precautionary Demand for Money Speculative Demand for Money The Demand for Money
The three motivates for holding money combine to create a demand for money curve. Def: The demand for money curve represents the money people hold at different possible interest rates, ceteris paribus. Why is it downward sloping? Example of Graph The Demand for Money Curve
Example of a Graph
The supply of money is a vertical line (MS) implying that the quantity of money supplied is independent of the interest rate Why? Show equilibrium The Equilibrium Interest Rate
Example of MS
What happens if the Fed increases the money supply? The opportunity cost of holding money falls enough that the public is willing to hold the now larger stock of money
How the Fed Controls the MS? The establishment of reserve requirements for banks Buying and selling U.S. government securities and other financial assets in the open market The volume of loans extended to banks and other institutions The interest rate it pays banks on funds held as reserves
http://www.youtube.com/watch?v=HdZnOQ
Recent Monetary Policy Increase in the monetary base from $828 billion at mid-year 2008 to $1.63 trillion in early 2009 to more than $2 trillion in 2010. Lower interest rates
http://www.pbs.org/newshour/updates/business/ju
http://federalreserve.gov/newsevents/press/monet
Example of lowering the interest rate
Interest Rates and Investment Suppose the Fed purchases U.S. government bonds. What happens to Investment? What happens to AD?
Example of Investment and Interest Rates
Adding the Short-Run Aggregate Supply Curve For a given shift of the aggregate demand curve, the steeper the short-run aggregate supply curve, the smaller the increase in real GDP and the larger the increase in the price level.
Example of Graph of SRAS
Def: Monetarism is the theory that changes in the money supply directly determine changes in prices, real GDP, and employment They put the spotlight on the money supply. They argue that to predict the condition of the economy, you simply look at the money supply. Too much money supply = higher inflation Too less money supply= unemployment and deflation The Monetarist View of the Role of Money
Def: The equation of exchange is an accounting identity that states the MS time velocity of money is equal to total spending: MV=PY The Equation of Exchange
It is assumed by classical economists that V and Y(real output) are fairly constant. Why is this true? Def: The Quantity Theory of Money states that changes in the money supply are directly related to changes in the affect of price level. The Quantity Theory of Money
Today, we do not think that V is constant and the employment does not always operate at full employment M& P are correlated, but not perfectly correlated. Modern Monetarism
Targets Before 1982 Between World War II and October 1979- the Fed attempted to stabilize interest rates. Friedman said this made monetary policy a source of instability in the economy because changes in the money supply reinforced fluctuations in the economy. He said pay less attention to interest rates and instead focus on a steady and predictable growth in the money supply Monetary rule
Targets After 1982 Less force on a steady and predictable growth in the money supply. The force was on a targeted federal funds rate.

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Chapter15 monetarytheory-and-policy-140831163822-phpapp02

  • 2. Why would people hold money? Transactions Demand for Money Precautionary Demand for Money Speculative Demand for Money The Demand for Money
  • 3. The three motivates for holding money combine to create a demand for money curve. Def: The demand for money curve represents the money people hold at different possible interest rates, ceteris paribus. Why is it downward sloping? Example of Graph The Demand for Money Curve
  • 4. Example of a Graph
  • 5. The supply of money is a vertical line (MS) implying that the quantity of money supplied is independent of the interest rate Why? Show equilibrium The Equilibrium Interest Rate
  • 7. What happens if the Fed increases the money supply? The opportunity cost of holding money falls enough that the public is willing to hold the now larger stock of money
  • 8. How the Fed Controls the MS? The establishment of reserve requirements for banks Buying and selling U.S. government securities and other financial assets in the open market The volume of loans extended to banks and other institutions The interest rate it pays banks on funds held as reserves
  • 10. Recent Monetary Policy Increase in the monetary base from $828 billion at mid-year 2008 to $1.63 trillion in early 2009 to more than $2 trillion in 2010. Lower interest rates
  • 13. Example of lowering the interest rate
  • 14. Interest Rates and Investment Suppose the Fed purchases U.S. government bonds. What happens to Investment? What happens to AD?
  • 15. Example of Investment and Interest Rates
  • 16. Adding the Short-Run Aggregate Supply Curve For a given shift of the aggregate demand curve, the steeper the short-run aggregate supply curve, the smaller the increase in real GDP and the larger the increase in the price level.
  • 17. Example of Graph of SRAS
  • 18. Def: Monetarism is the theory that changes in the money supply directly determine changes in prices, real GDP, and employment They put the spotlight on the money supply. They argue that to predict the condition of the economy, you simply look at the money supply. Too much money supply = higher inflation Too less money supply= unemployment and deflation The Monetarist View of the Role of Money
  • 19. Def: The equation of exchange is an accounting identity that states the MS time velocity of money is equal to total spending: MV=PY The Equation of Exchange
  • 20. It is assumed by classical economists that V and Y(real output) are fairly constant. Why is this true? Def: The Quantity Theory of Money states that changes in the money supply are directly related to changes in the affect of price level. The Quantity Theory of Money
  • 21. Today, we do not think that V is constant and the employment does not always operate at full employment M& P are correlated, but not perfectly correlated. Modern Monetarism
  • 22. Targets Before 1982 Between World War II and October 1979- the Fed attempted to stabilize interest rates. Friedman said this made monetary policy a source of instability in the economy because changes in the money supply reinforced fluctuations in the economy. He said pay less attention to interest rates and instead focus on a steady and predictable growth in the money supply Monetary rule
  • 23. Targets After 1982 Less force on a steady and predictable growth in the money supply. The force was on a targeted federal funds rate.