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Topic 11 Money, Banking, and the Monetary Policy

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Money. Money, the median of exchange, is a commonly accepted object in exchanging goods ... Reserve is the amount of money kept by banks ... – PowerPoint PPT presentation

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Title: Topic 11 Money, Banking, and the Monetary Policy


1
Topic 11 Money, Banking, and the Monetary Policy
  • Money
  • Banking System
  • Creation of Money
  • Monetary policy
  • Fiscal and Monetary policies are both important

2
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

3
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.

4
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
5
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.

6
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

7
Monetary policy
  • An Expansionary Policy
  • MS?, gt r ? gt I ? gt AD?
  • A Contractionary Policy

8
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
9
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.

10
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

11
Dilemma in Demand Side Management
  • Is there a dilemma to fight recessions?
  • Is there a dilemma to cool down the economy?
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