14 chapter 14 monetary policy by 5K4v9Jq8

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									Monetary Policy
Opportunity Cost of Holding Money
Short-term interest rates are the interest rates
on financial assets that mature within six
months or less.

Long-term interest rates are interest rates on
financial assets that mature a number of years
in the future.
Opportunity Cost of Holding Money
Money Demand Curve shows the relationship
between the quantity of money demanded and the
interest rate.
The Liquidity Preference Model of the Interest Rate
Price Level and Money Demand
     Prices and Demand for Money
The real quantity of money is the nominal quantity
of money divided by the aggregate price level.
Real Demand for Money

        Change in Aggregate Prices
        DOES NOT SHIFT
        Real Money Demand Curve!
Shifting Real Demand for Money
Changes in Real Aggregate Spending
  If you plan to buy more stuff, you need more
  money to facilitate those transactions

Changes in Technology
    ATMs and Credit Cards reduce the need to
  hold cash or even checkable deposits.

Changes in Institutions
Liquidity Preference Model:
       Money Market
          Setting the Federal Funds Rate
- Pushing the Interest Rate Down to the Target Rate

                                   The target federal
                                   funds rate is the
                                   Federal Reserve’s
                                   desired federal funds
                                   rate.
      Setting the Federal Funds Rate
- Pushing the Interest Rate Up to the Target Rate
The Fed Moves Interest Rates
 Monetary Policy and Aggregate Demand

Expansionary monetary policy is monetary policy
that increases aggregate demand.

Contractionary monetary policy is monetary
policy that reduces aggregate demand.
Expansionary Monetary Policy to Fight a Recessionary Gap
Contractionary Monetary Policy to Fight an Inflationary Gap
Monetary Policy and the Multiplier
The Short-Run Determination of the Interest Rate
Federal Reserve Policy and the Business Cycle
The Short-Run and Long-Run Effects of an Increase in
                the Money Supply
           Monetary Neutrality
In the long run, changes in the money supply
affect the aggregate price level but not real GDP
or the interest rate.

In fact, there is monetary neutrality: changes
in the money supply have no real effect on the
economy. So monetary policy is ineffectual in the
long run.
The Long-Run Determination of the Interest Rate
Velocity Approach to Money Demand
The velocity of money is nominal GDP divided by
the nominal quantity of money.
                                   Nominal
                                    GDP

According to the velocity of money approach to
money demand, the real quantity of money
demanded is proportional to real aggregate
spending.
                                      Nominal
                                       GDP
             Velocity in the U.S.
                                  Nominal
                                   GDP
Calculate Velocity (V) for the U.S.
October 2007 Nominal GDP = 13,926.7 billion
October 2007 M1 Money Supply = 1370.3 billion
October 2007 M2 Money Supply = 7395.8 billion

         Nominal GDP 13,926.7 billion
      V=                               10.16
         Money Supply   1370.3 billion

         Nominal GDP 13,926.7 billion
      V=                              1.88
         Money Supply 7,395.8 billion
    “Quantity Theory of Money”
This equation is called the quantity equation:


Economists usually assume that Velocity (V) is
relatively fixed / constant.

If V is constant, and Y is determined by the
factors of production (think potential output)
then there is a relationship between M and P.
   “Quantity Theory of Money”

   If V and Y are fixed then both = zero

       ΔM + ΔV = ΔP + ΔY
           ΔM = ΔP

M and P will generally move in the same direction!

     Printing money causes inflation !!!
Relationship Between Money and Inflation
       U.S. Example to Prove It
            ΔM = ΔP + ΔY
Calculate Change in Y (real GDP):
  Real GDP Q3 2006: 11,336.7 billion
  Real GDP Q3 2007: 11,630.7 billion
     2.59 %
Calculate Change in P (CPI):
  CPI October 2006: 201.8
  CPI October 2007: 208.936
     3.52%
 U.S. Example to Prove Relationship
            ΔM = ΔP + ΔY
    Predicted ΔM = 3.52% + 2.59%
        Predicted ΔM  6.11%
So, using the Quantity Theory and real data on the
U.S. economy we would predict that the U.S.
Money Supply increased by 6.11%

What really happened? Let’s look up M2 which is
our best measure of the Money Supply.
Liquidity Preference Model:
       Money Market

								
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