Econ 180
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- 3 Goals of Monetary Policy
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FEP
1) Full employment
2) Price stability
3) Economic growth - Many economists argue that the Fed's primary goal should be
- Price stability
- The Federal Reserve System is the instrument of
- Monetary policy
- The Fed has to balance these goals
- Inflation vs. Recession
- The Fed develops monetory policy suurounded by
- A whirl of other political events and considerations
- Expansionary Monetary Policy is designed to
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Stimulate the economy
1) "loose" monetary policy
2) increase money supply
3) shifts aggregate demand right - Contractionary monetary policy
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1) slow down the economy
2) tight monetary policy
3) decrease monetary policy
4) shifts aggregate demand left - What do the Fed do to balance these goals
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1) manage the money supple itself
2) manipulate short term interest rates - Demand for money
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The quantities of money that people would like to hold at various nominal interest rate, ceteris paribus.
1) Price/opportunity cost
2) downward sloping curve - Transaction Demand
- People need to hold cash to carry out myriad daily transactions
- Precautionary demand
- People feel need to hold extra cash in bank to pay for unforeseen expenses.
- Speculative Demand
- People hold cash when current financial investments are relatively unattractive, in the expectation that future returns on investment will rise, and they will be ready to invest in them
- Demand for money curve
- downward sloping
- Money Supply Curve
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1) It is depiced as a vertical
2) It is independent of the interest rate
3) It is assumed that this is the quantity of money supplied to the economy by the Fed - Higer than equilibrium
- Rate will fall to equilibrium
- Lower then equilibrium
- Rate will rise to equilibrium
- Price rule
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Conducting monetary policy in order to keep price increase in basic commodities (incl. gold) within a low range.
1) Fed's primary concern appears to be price stability - The Equation of Exchange - Money & Price
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M x V = P x Q
Total Spending = Nominal GDP
M = Quantity of money
V = Velocity of money
M x V = Total spending
P = Price index (economy's price level)
Q = Aggregate output of goods and services
P x Q = nominal GDP - Quanitity Theory of Money
- A theory based upon the equation of exchange; shows that the effect of a change in the money supply is a proportional change in the price level; assumes velocity and aggregate output remain constant.
- Velocity of money
- Is independent of the supply of money in the long run, therefore a constant
- Aggregate Ouput (Q)
- Is independent of the supple of money in the long run; Q depends on productive capacity of economy which is assumed to be at max, therefore a constant
- Monetarism is a school of thought that emphasizes
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1) inportance of the quantity of money in the economy
2) a rule for monetary policy - Monetarists acknowledge the existence of
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1) short run quantity of money may affect velocity and aggregate output in short run
2) Change in Q = decrease money supple - economy slow down
3) Change in V = speed up money turnover - Monetarists recommend a "monetary rule"
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Fed increase money supply at steady rate (equal to or slightly greater than long run growth in aggregate output)
Result
1) Full employment growth
2) zero inflation