Review of Monetary Policy

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					Review of Monetary Policy
First, a few points from Ch.22
Fluctuations in US Real GDP, 1920-2007
    What if we take the trend out
Short-Run Fluctuations (business cycle)

500.00

400.00

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200.00

100.00

  0.00
          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          20

          20

          20
             60

             63

             66

             69

             72

             75

             78

             81

             84

             87

             90

             93

             96

             99

             02

             05

             08
-100.00

-200.00

-300.00

-400.00

-500.00
So, you see positive & negative gaps

  500

  400

  300

  200

  100

    0
         19

         19

         19

         19

         19

         19

         19

         19

         19

         19

         19

         19

         19

         19

         20

         20

         20
            60

            63

            66

            69

            72

            75

            78

            81

            84

            87

            90

            93

            96

            99

            02

            05

            08
  -100

  -200

  -300

  -400

  -500
  What happens in the business cycle

• Inflation generally decreases in a recession
Unemployment generally increases in a recession
What happens in the business cycle?

Output gap is the difference between potential GDP (output
trend, long-term growth path) and actual GDP

   Recessionary gap (recession): actual GDP < potential
   GDP
        • Inflation low
        • Unemployment high (high cyclical
        unemployment)

   Expansionary gap : actual GDP > potential GDP (output
   rises too fast)
           • Inflation high
           • Unemployment low (little cyclical unemployment)
          Policy Question
• What should the Fed do? Ch.24
• First, need to know Fed objectives for its
  monetary policy
• Ask the book author & now Fed Chairman
   What to do in a recession?
• Spending (& GDP) generally falls in a
  recession
• Inflation falls
• Unemployment rises
• The Fed can raise the money supply, so…
  – Fed funds rate/discount rate will fall
  – Other interest rates will fall
  – Investment/consumption spending will rise
  – Production (GDP) will rise
     See the Fed’s reaction (function) in this
          business cycle … it is trying

6                                                  6

4                                                  5
2
                                                   4
0
       2006         2007               2008   2009 3
-2
                                                   2
-4

-6                                                 1

-8                                                 0
                GDP Growth   Fed funds rate
       Is there any downside?

• Remember: we are talking about only the short
  run so far
• In the long run, the economy (long-term
  economic growth) is determined by real factors
  (Ch.19), not MONEY
• In the long run, too much money leads to only
  inflation (Ch. 21--Quantity Theory of Money)
• Is this just a myth? Let’s see what happens if
  you try…
A tale of Zimbabwe
Money is sometimes evil
             What’s Ahead
• Nov 17: Foreign Exchange, Ch. 27
• Nov 24: Trade & Capital Flow, Ch. 28
• Dec 1: Review
  – Review for exam
  – Where all material fits in the program
• Take-Home Exam
• April 22: Assignment due (monetary policy)
Video: What if there’s too
     much money?

				
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posted:3/8/2012
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