Chapter 14 Modern Macroeconomics and Monetary Policy remember the demand for money balances is not the same as the demand for wealth reasons to hold money buy stuff now in case of emergency buy stuff later demand for money illustrates the relationship between interest rate and quantity of money people want to hold downward sloping the opportunity cost of holding money is the nominal interest rate shifts right when nominal GDP rises shift left when nominal GDP falls and as people use more electronic transactions supply of money the Fed controls the supply of money through the reserve requirement open market operations federal funds rate discount rate and interest paid on excess reserves vertical changes in the interest rate do not impact the Fed s ability to control the money supply o o o restrictive monetary policy when the Fed sells bonds supply of money decreases supply of loanable funds decrease AD shifts left because a higher interest rate makes current investment and consumption more expensive therefore decreasing it a higher interest rate causes financial assets to appreciate the US dollar net exports will fall and asset prices will decrease when monetary policy is timed correctly it will help mitigate a recession it will help control and prevent inflation and it will lead to economic stability when monetary policy is timed incorrectly it will make recession even worse it will lead to massive inflation and it will lead to economic instability it takes 6 15 months to impact real output and 12 30 months to impact price level and inflation monetary policy in the long run quantity theory of money a theory that says a change in the money supply will cause a proportional change in the price level PY MV p price level Y real GDP M money supply V velocity of money PY nominal GDP rate of inflation growth rate of real output growth rate of money supply growth rate of velocity velocity of money average number of times a dollar is used to purchase final goods and services during a year in the short run expansionary policy will increase output and restrictive monetary policy will reduce output in the long run expansionary policy will only lead to inflation limitation of monetary policy expansionary monetary policy cannot promote long term economic growth economists have limited forecasting abilities and price stability is key to economic prosperity Austrian view of the business cycle expansionary monetary policy pushes the interest rate to an artificial low the low interest rates will induce entrepreneurs to undertake long term investments which will generate an economic boom however the boom will be unstable because savings are too low to purchase new assets the boom turns to a bust and a large share of the newly constructed assets end up unoccupied THIS IS REFERRED TO AS MALINVESTMENT o o o o o o o impact of stop go monetary policy o monetary policy is variable over the past decade o o it is likely to increase economic instability it is hard for monetary policy makers to institute stop go policy in a stabilizing manner All content belongs to Dr Sherron of Florida State University I do not own this material I will remove the material upon request of Florida State University
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