Topic 11 Money, Banking, and the Monetary Policy

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Topic 11 Money, Banking, and the Monetary Policy

• Money
• Banking System
• Creation of Money
• Monetary policy
• Fiscal and Monetary policies are both important

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Money

• Money, the median of exchange, is a commonly
  accepted object in exchanging goods and services.
• Barter economy
• Money as commodities with intrinsic value
• Fiat Money (Paper money)
• Has no intrinsic value but is commonly accepted

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Money Supply

• Money supply is the amount of money in
  circulation.
• M1 is the sum of all coins and paper money in
  circulation, plus checkable deposit balances at
  banks. It is a typical measure of money supply.

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Banking System

• Federal Reserve Bank regulates banks
• Why regulate? 1.
• 2.
• How to?
• Reserve is the amount of money kept by banks
• Require reserve is the minimum amount of reserves
  required by law. Normally, required reserves are
  proportional to the volume of deposit.
• Required reserve ratio is the fraction of deposit
  that must be kept in banks.

Assure safety of deposit
Manipulate money supply to control AD
Set required reserve ratio
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Money Creation

• How much will money supply increase, if FED
  increases reserve by 1 dollar while required
  reserve ratio is 0.2?
• ?money supply(1/m)x ?reserve
• m required reserve ratio
• Open Market Operation
• When FED increases banks reserve, it receives
  government securities from them.

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Monetary Policy

• Monetary Policy refers to actions that the FED
  takes to change the money supply, move interest
  rate or both. It aims to affect AD.
• How does the Fed conduct monetary policy?
• Expansionary policy in recessions.
• Target a lower interest rate
• Use Open Market Operation
• Contractionary policy when the economy gets too
  much heat

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Monetary policy

• An Expansionary Policy
• MS?, gt r ? gt I ? gt AD?
• A Contractionary Policy

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Monetary Policy and Fiscal Policy are both
important

• Monetary policy affects investment which could
  respond with lag.
• Fiscal policy has policy lag but C or G could
  respond more quickly.
• Fiscal policy should work with Monetary Policy
• A fiscal policy expanding AD gt______ gt_____gt
  _______gt_______
• If the FED ______________________, then the
  adverse effect may not happen.

r ?
MD ?
I ?
AD ?
target the same r, ? MS
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Topic 12 Philips Curve

• Philips Curve shows the empirical relationship
  between inflation rate and unemployment rate
• In the US, the Philips Curve sloped downward in
  the short run but was vertical in the long run.

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SR and LR Philips Curves

• SR Philips Curve Unemployment rate and inflation
  rate had negative correlation.
• Why did US experience such trade off?
• LR Philips Curve Unemployment rate was
  independent of inflation rate
• Can we break short run Philips Curves?
• Adverse Supply Shock
• Favorable Supply Shock. The New Economy

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Dilemma in Demand Side Management

• Is there a dilemma to fight recessions?
• Is there a dilemma to cool down the economy?