CHAPTER 15 MONETARY POLICY

The opportunity cost of holding money

Short-term interest rates mature within 1 year of less
Long-term interest rates mature in a number of years in the future
The money demand curve shows the relationship between the
interest rate and the quantity of money demanded.
The money supply curve is vertical as chosen by the Fed.
The Fed controls the equilibrium, providing at a certain money
supply, controlling demand by performing open market
operations.

Shifts of the real money demand curve:

Changes in aggregate price level
Changes in real GDP
Changes in technology
Changes in institutions
Monetary policy by the Fed
Fed buy T-Bills, pays with new money
Leads to new lending by the commercial banking system
Shifts money supply curve outward
Lowers the equilibrium interest rate.
Lower interest rate (higher planned investment) cut money supply open market sale
Higher interest rate (lower planned investment) add money supply open market purchase
Suppose to raise the interest rate, the Fed has to reduce money supply by 500 million.
If the rr is .10, the total change in the money supply to be 500 million need to be:
Monetary base/rr = -500 million
Monetary base = -50 million

What the Fed wants, the Fed Gets

The Fed can move AD to wherever it wants
It can do so much faster than Fiscal Policy
No debate
Investment is much more volatile than consumption
Change course easily
Superior to Fiscal in fighting recession
Feds job to perform counter-cyclical policy: keep aggregate demand at potential output
Contractionary monetary policy is sometimes used to eliminate inflation that has become
embedded in the economy.
In the short run, policies that produce a booming economy also tend to increase inflation
In the long run,

Monetary neutrality: changes in the money supply have no real effects on the economy.
In the long run, changes in the money supply affect the aggregate price level but not GDP
Whatever the Fed has done will be undone