1 lecture 11 mod 6.1: monetary policy c.l. mattoli (c) red hill capital corp., delaware, usa 2008

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Lecture 11 Mod 6.1: Monetary Policy C.L. Mattoli

(C) Red Hill Capital Corp., Delaware, USA 2008

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This week

Mod 6 part 1: Monetary Policy Textbook, Chapter 16

Macroeconomic Policy 1:

Monetary Policy


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Learning objectivesOn successful completion of this part of the

module, you should be able to: Explain the nature and operation of monetary

policy Discuss differences between ‘classical’ and

‘modern’ monetarist doctrine Articulate the ‘rules’ versus ‘discretion’

debate over the role of monetary policy Explain how monetary policy is

implemented in Australia


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Where we are coming from The last several modules have been

spent looking at macroeconomic variables, and then using them in an aggregate model of supply and demand.

We found that classical economists believed that an economy would always heal itself and forever be able to give everyone a job. That is the classical end of the aggregate supply curve.


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Where we are coming from Keynes found another limiting case in

which people would be unemployed and remain unemployed unless something was done by the government: a kick start.

In the last lecture, we looked at what makes money money.

Governments print modern money and issue it through their central banks and their banking systems.


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Where we are coming from This fiat money is valued against the

economy. The amount in circulation will affect its value.

For example, if the supply doubled overnight, no one would be fooled, they would just revalue everything else at prices twice as much as yesterday. Thus, keeping a reign on the supply is important, at least for prices.

Indeed, since there will be both a supply and a demand for money, there will be an intersection of those curves and an equilibrium price.


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Where we are coming from We call the price of money the interest

rate. Since the government is the one who

makes money, by printing it, minting it, and allowing banks to create it, the government can also have an affect on money supply, which can affect other variables in the economy, like interest rates, investment, output, prices, and employment.


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Where we are coming from The economy will have demand for

money, and the government can manipulate supply

In this lecture, we take a closer look at money and monetary policy, i.e., how the government views money and uses it to affect interest rates, and the effects that are transmitted through the economy from what the government does about money.

We shall look at money views, theories, transmission mechanisms, and practical applications to try to affect an economy.


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On Monetary policy


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Tools available to a central bank There are 2 common means by which the central

bank can affect money supply and demand.1. First, it can affect interest rates. The central bank can change the rate of interest

that it charges to its member banks. That rate, in turn, will act as a baseline rate for

interest rate costs of banks, in the shortest, overnight market for money.

That will be transmitted through others interest rates in the banking system and in the economy for longer maturities and differing risks and costs of lending in its various venues.


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Tools available to a central bank2. Alternatively, the bank can make it

known what it wants the overnight, inter-bank loan interest rate to be, and let the market work it out. The result, in either case, will be that demand will adjust to supply of money at the new price (interest rate) of money and a new quantity.


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Tools available to a central bank3. It can also affect supply of money in the system

through open market operations. In open market operations, the central bank either

sells or buys U.S. government securities from its member banks.

The banks, as part of the system, are obliged to enter these transactions.

If banks buy securities from the central bank, they with money, thus, taking money out of the banking system, thus reducing supply of money from banks.


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Tools available to a central bank Cash is deducted from the bank’s ESA,

immediately reducing the money bas, and though the multiplier will reduce the other definitions of money supply.

Dollars are physically removed from the economy.

The opposite occurs when the central bank buys securities from banks. More money is put into circulation.


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Open market operations

RBA

Banks

Public

RBA sells Securities; banks

Buy; bank deposits at RBA decline

Banks have more moneyThey increase loans

Interest rates decline

Banks have less moneyThey decrease loansRaise interest rates

RBA buysSecurities; banksSell; deposits at

RBA increase


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The RBA’s goals of monetary policy As we learned in the last lecture, the RBA

was originally given a mandate of keeping a stable currency, maintaining full employment, and ensuring economic prosperity and welfare of the Australian people.

Then, that goal seemed to be limited to keeping inflation between 2 and 3 percent on the CPI in the last decade, but does that mean that it has abandoned the other 2 goals?


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The RBA’s goals of monetary policy In fact, the RBA believes that by pursing that

one goal, it will, in addition, take care of the other 2 in the medium to long term.

The logic is that: It would take away its focus, if it went chasing after different problems in the short run.

1. Inflation can have other affects on an economy, like causing bad expectations and increasing interest rates.


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The RBA’s goals of monetary policy2. If it keeps its eye on inflation and keeps it

low, through ups and downs, then, economic growth will come. Moreover, with growth, there will be employment.

We can look at the record of monetary policy versus history.

We can discuss some theories and some prescriptions for what monetary policy can and should do.


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Policy Transmission


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Intro The central bank can affect the supply of money,

thus, tinkering with the equilibrium point between supply and demand for money.

The equilibrium will be a quantity of money and a price of money, the interest rate.

The bank can change the supply of money or it might also set the interest rate directly.

By setting supply at a certain vertical quantity, the bank might be trying to pick a spot on the money demand schedule, which will be at a certain interest rate.


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Intro If it sets the rate, it is trying to bring the

demand curve to a certain point of implied supply.

After it becomes clear where the central bank wants interest rates be, both HH and businesses will make savings, borrowing, and investing decisions.

Those decisions will, in turn, affect other variables in the economy.

For example, when rates are high, both business and HH will be more unlikely to borrow.


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Intro Consumers buy large durable goods for large

dollar amounts, like appliances, cars, land, and houses with borrowed money, while business borrow money to invest in capital.

People will tend to save money and try to take advantage of the interest rate.

That will take money out of the system. It will take money out of DI and put it into S,

so C will decrease.


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Intro Business will also borrow less and invest less,

causing I to decline Thus, interest rates will ultimately affect AD. If the affect is a decrease in AD, then, there may

also be a decrease in employed people. If AD increases, it may lead to more employment

in the economy. It may also lead to increased prices and inflation. We shall examine some ways that monetary

policy can be transmitted through the economy, so we can understand the consequences of tinkering with the supply of paper money.


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The Keynesian mechanism Suppose an economy is operating near its

capacity and increased inflation has begun to appear above the previously lower more stable rate.

The central bank would then tighten money, reduce supply, and the interest rate would rise.

That would cut private-sector demand in I and C (for durable goods, at least), which would have a multiplier effect through the economy, and AD would decrease.


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The Keynesian mechanism The fall in AD would slow down

economic activity and reduce the rate of inflation.

Thus, in the Keynes view, interest rate changes are the key to the transmission process.

We show the causal chain of events, in the next slide.


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The Keynes Causal Chain

Change inMoneyPolicy

Change inMoney Supply

Change inInterestRates

Change inInvestment

Change inAggregate

Demand

Change inPrice, GDP,Employment


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Monetarism


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Monetarist school The monetarist school of thought is that

changes in the money variable have far more direct and vast effects on economic variables.

In the Keynes transmission, money policy affects interest rates. Then, investment and AD. Then, prices, output, and employment. It is a cascade effect: a chain of events.


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Monetarist school

The monetarist view is that changes in money supply directly affect prices, output and employment, in addition to interest rates.

We show the causal chain for monetarism in the next slide.


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The Causal Chain: monetarism

Change inMoneyPolicy

Change inMoney Supply

Change inInterestRates

Change inInvestment

Change inAggregate

Demand

Change inPrice, GDP,Employment

Monetarist Chain Shortcut

Keynes Route


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The monetarists’ logic Modern monetarism has its roots in

classical economics. It puts the spotlight on the money supply

as a large determinant in the economic outlook.

Simplistically, if the supply expands too rapidly (whatever that means), prices will rise and there will be inflation.


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The monetarists’ logic An extreme example is, if the supply

doubles, overnight, prices will double because no one is fooled...the money is worth half as much as it was worth, yesterday.

If the supply expands too slowly to meet the economy’s transaction needs, prices might fall or people might lose jobs.


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The equation of exchange We begin with the classical economics

equation of exchange, a classical notion from the 19th century.

It is simply an accounting identity relating the supply of money, M, to the times it is spent, turned over, in a year (period).

The annual (period) turnover is referred to as money velocity, V.

Then, the equation relates money spent to nominal GDP (=PQ) as: MV= PQ.


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A simple economy Assume an economy with only one $20 bill in

circulation. Linlin has the $20 and wants to eat fish, so

she pays $20 to Tintin for fish. Now, Tintin has the money, and she decides

to go to go to Shadow’s wang bar and spend her money on internet, tea and crumpets.

Now, Shadow decides to go to Violet’s nail salon to have a facial and her nails done.

Thus, in our quick little jaunt, the single $20 has paid for $60 in G&S. Money gets around.


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A simple economy: abstracted Thus, you can visualize how the equation is

simply a statement of reality. Money gets around an economy, and the

number of transactions that it is involved in, during some period of time, determines the total value of the transactions that are done, which is the economy’s nominal value of GDP, during that time.

The question becomes: how are Q and P, in GDP, separately affected. That would be more useful information.


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A larger example Consider an economy with a GDP of $500

billion and M1 of $100 billion. Then, solving the exchange equation we

find that the velocity was V = GDP/M1 = $500 billion/$100 billion = 5.

Thus, M1 was turned over 5 times during the year, going through an average of 5 transactions for final goods and services, to pay for total output of the economy in current dollars.


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Quantity theory of money In classical economics, V and Q are regarded

as constants. It assumes that people have stable spending

habits, and it is also under the broader assumption that prices are flexible and everyone is employed.

The resulting quantity theory of money, then, says that the change in money supply determines inflation, as MV0 = PQ0, where V0 and Q0 are now constants.


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Quantity theory of money It may have been an ok assumption in the

19th century, and the argument has some appeal, in a certain sense.

However, it misses supply shock, cost push inflation, like happened in the 1970’s with oil prices.

It also loses predictive power, if V is not actually constant but varies, for one reason or another.


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Quantity theory of money For example, financial innovation,

like occurred in the 1980’s & 90’s with EFTPOS on the rise, the need for pocket money changed substantially.

If an economy does not have full employment, changes in money might translate into increased output, not prices.


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Modern monetarist thinking

The historical record shows that velocity is not unwavering.

Monetarists acknowledge that reality but argue that V is fairly predictable.

Then, if predicted V for next year is 6, GDP will be $600 billion.


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Modern monetarist thinking Then, predictions of changes in prices

versus output are tempered by where the economy is in the range between Keynes and classical on the AS curve.

The monetarist prescription is, then, do not let the money supply grow too fast or too slowly, and you will be able to keep inflation and unemployment under control.


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Keynes vs. monetary transmission The monetarists deemphasize the

transmission of money changes through the interest rate as an intermediary.

In that regard, when people find themselves with extra money in their hands, they will not just go out and buy bonds, they will also spend money on more G&S.

Thus, instead of just bidding up bond prices and changing interest rates, prices of G&S will be bid up and demand will increase.


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Keynes vs. monetary transmission Instead of working through interest rates to

investment to AD, the change in money directly determines economic activity.

A famous “thought experiment” imagines that a community wakes up to find $50 bills littered everywhere.

Some people will invest it, others will rush out to buy CD players, flat screen TV’s, computers, cars and new clothing and food.

The result will an increase in bond prices and nominal GDP, albeit mostly an increase in prices.


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The Role of Monetary Policy


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Rules vs. Discretion Debate Both schools of thought on money agree that

monetary policy will affect the economy. They would further agree that the short-term

affects, about the first 9 months, will be responses in output and employment, with inflation following at about 18 months out.

However, they differ in their views of the role of monetary policy.

Keynesians believe that the central bank should have discretion to change its policy to meet changing perceived problems in the economy.


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Rules vs. Discretion Debate Monetarists, on the other hand, believe that

the banks should adhere to widely-published rules of engagement. The most common of which is a target range for money supply growth.

Monetarists would, for example, argue that countercyclical monetary policy will suffer from information lags, decision and implementation lags, and effectiveness lags, and such policy pursuit might actually exaggerate swings in the cycle instead of damping them.


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Lags & Nags First, since information is imperfect and

partially visible, there will be an information lag about the actual state of the economy.

As the outlook on the economy crystallizes, policy finally takes shape, but again at a lag, and implementation thereafter occurs.

Then, there will be the final lags between implementation of policy and affects in the economy.

By the time that all follows, it might be the wrong affect at the wrong time.


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Lags & Nags The monetarist would prescribe that the

central banks should announce targets of monetary growth for a year. Then, use the tools available to it to keep the growth of supply in line with the target, and review the target annually.

For example, if we want GDP growth to be in the range 5-6%, with real growth and inflation in the 2-3% range, then, money supply should be grown at that rate.


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Lags & Nags Indeed, even if velocity varies to result in

temporary inflation or slower growth in output, policy should remain steadfast.

The Keynesian would say: ok, don’t just do something, stand there!

The monetarist believes the head of the central banks should be a horse. Each year the horse would be debuted to the public. He would tap his foot 4 times for 4% growth in M, then, not be seen again for another year.


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Velocity instability The predictability of velocity is a central

issue in the debate of targeted money growth or a discretionary approach.

Most economists would agree that velocity is not stable in the short run. They disagree on its behavior over the longer run.

Keynesians do not accept the monetarist view that velocity evolves in a fairly stable and predictable manner over the longer run.


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Velocity instability Keynesians believe that velocity is

determined by the community’s demand for holding money balances, and that demand for money is not stable in the short or long run.

If velocity is not stable or predictable, then, a change in supply could result in a change in nominal GDP that is either larger or smaller than monetarists would predict.


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Velocity instability Keynesians argue further that even if the

long term is predictable, the focus of policy should be on the short term where the velocity is not stable, and, therefore, the monetarist approach is worthless.

Suppose, for example, that the money supply is increasing at a constant rate.

Then, if velocity is greater than predicted, total spending will be greater than expected, creating inflation.


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Velocity instability If velocity is smaller than predicted, the

economy will expand at a slower pace than expected, and unemployment will result.

Keynesians believe that the central bank needs to act to adjust for changes in velocity.

Monetarists argue that predictability of short term velocity is not possible, so the response of central banks will be wrong, anyway.

Keynesians argue that the flexibility option should be kept as a better alternative to keeping money supply growth constant.


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Case StudyMoney & Policy


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Intro The cycle of a new economic theory from

inception in academia to acceptance in academic circle, the, in real world practice seems to be about 10-15 years.

Keynes theory had its greatest acceptance in academia in the 1940’s & 50’s, while its use in policy applications was mostly in the 1960’s.

Monetarism gained academic support in the late 1950’s with its strongest support, in academia, coming in the late 1960’s, and its policy début in the mid-1970’s.


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The Great Depression During the 1920’s in the U.S., the

money supply grew at a steady pace and prices were stable.

The huge stock market crash of 1929 caused bank failures, a decline in GDP and unemployment.

Through the years 1929-1933, the central bank allowed M1 to decline by 27%.


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The Great Depression The evolution of the story is that foreign

banks, afraid of the state of U.S. banks, withdrew large amounts of gold from U.S. bank.

The central bank responded by raising the interest rate that they charge to banks.

Bank responded by borrowing less. The result was a sharp contraction in the money supply.


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The Great Depression Monetarist would argue that, assuming

that velocity was fairly stable, GDP, employment and prices would decline.

The record was that real GDP declined 30%, prices declined 24%, and unemployment rose from 3.2% to 24.9%.

Monetarists gain further credence from the fact that after the central bank began using open market operations to increase supply in 1931, the economy did begin to move out of deep recession with a time lag.


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The Great Depression The situation was, however, further

exacerbated by fiscal policy, the topic of the final lecture, as the U.S. president also tried to have a balanced budget rather than pursuing a Keynesian policy of fiscal expansion of spending to kick start the economy.

Economic data is shown in exhibit 16.3 in the textbook, in graphical form.


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Australia 1976-85: monetarism policy Runaway inflation in the 1970’s gave the

monetarist economists their try at positively affecting the economy in many countries around the world.

Australia engaged in a form of money supply growth targeting between 1976 and 1985.

Each year the treasury would announce conditional projection of growth of M3 in its budget projection.


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Australia 1976-85: monetarism policy The RBA was, then, expected to keep it near

that figure. The conditional part of the target left leeway

for changing foreign and domestic economic events.

The record over the period shows that the RBA had varied degrees of success of bringing inflation under control. (See exhibit 16.4 in textbook.)

The record also shows that unemployment rose from 4.1% to 9.6% over the period.


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Post-1985: non-monetarist policy Financial institutional flexibility issues that

hamper the RBA during its monetarist policy experiment were solved by 1985, but the RBA concurrently abandoned money growth targeting.

The rationale for the change in policy was that, due to the financial deregulation that was taking place all around the world and the financial innovations that were developing in the markets, velocity was changing and was unpredictable.


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Post-1985: non-monetarist policy In exhibit 16.5 in the textbook, it can be seen

that velocity of M3 peaked at 0.7 in 1976, decreased to 0.5 by the end of the 1980’s, and has continued to decrease to a level of around 0.4, today.

A change in supply of money will have predictable effects for interest rates, only if the demand can be predicted fairly accurately. If demand cannot be predicted, changes in supply might actually add volatility to interest rates, which would adversely affect business mentality and economic output.


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Post-1985: non-monetarist policy A better method in those circumstances

would be to target rates, directly, at whatever level it is thought will support a certain level of AD. This type of approach is the one that has been adopted by the RBA since 1985.

As we mentioned in the last lecture, the RBA’s current mandate is to keep inflation in the 2-3% range.

The means of implementing the policy is to announce a target rate for the overnight cash rate (inter-bank, overnight rate).


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Post-1985: non-monetarist policy In order to enforce this target, the RBA allows

a certain amount of market discipline to adjust supply and demand to that rate.

In addition, the RBA carries out open market operations to adjust supply. Decreased supply will tend to increase interest rates, while increased supply will tend to reduce them, ceteris paribus.

Eventually, these cash rates spread through the wholesale and retail markets and into other interest rate markets.


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Linking money policy to AD-AS


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AD-AD response example Suppose that the RBA tightens credit. Then, AD will shift left, as shown, below.

Real GDP vs. Price level

AD1

AD2


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Graph analysis Suppose the RBA sells securities to the

banking system, thus, reducing the supply of money.

For any price level of the economy, the supply of money balances will be reduced, and interest rates will increase.

As interest rates increase, there will be less demand for investment and durable goods.


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Graph analysis That will have a transmitted affect on

overall aggregate demand through another multiplier.

Thus, AD will shift from position 1 to 2 on the graph.

As a final result real GDP will decrease. Although prices will not fall as a result of a

monetary tightening, the rate of inflation will be diminished.


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The shape of money supply When the RBA sets a target rate, that means

that it must be willing to supply the supply that will result in the target interest rate (the price of money), no matter what the demand curve shifts into.

The downward sloping demand curve might shift due to any number of reasons.

Since the supply must meet any demand at the target price, the supply curve is completely horizontal and elastic.


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A blunt instrument

Money policy cannot be focused but affects the broader economic community.

For example, if the central bank believes that a certain part of the economy is heating up or if it thinks that inflation is too high, it will raise its target cash rate, and all rates will be affected.


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A blunt instrument

Thus, there are those who will suffer, like borrowers with variable rate loans, or people who were planning on buying houses.

As a result, some good affects that might have been in the cards for the economy may be dashed by rising rates.


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Foreign Exchange Market ops Another means by which money supply can

be changed is through the foreign exchange markets.

Prior to 1983 when the Australian dollar was allowed to freely float in the markets for foreign exchange, any imbalance had to be met by the RBA.

Any action by the RBA in the FOREX markets would also affect money supply and, ultimately, interest rates and other economic variables.


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Foreign Exchange Market ops For example, if there was excess supply, the

RBA would have to buy AUD. That action had the affect of taking money out of the system, lowering the money supply.

Lower money supply would lead to higher interest rates would lead to unintended damping of economic growth.

In a floating exchange rate regime, the central bank does not need to involve itself in balances between supply and demand for currency in the foreign exchange markets: the markets must work out their own equilibrium.


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Foreign Exchange Market ops Nowadays the RBA, as do many other central

banks in countries with floating exchange rates, still does get involved in the markets when it deems it necessary.

There are two types of intervention that the RBA, today, employs: smoothing and testing.

If the markets are excessively volatile, the RBA might intervene to try to smooth out the volatility. Such operations might last several days, at most.


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Foreign Exchange Market ops When the RBA feels that there is too much

short-term speculative pressure on the AUD, it will engage in operations to counteract the pressure.

That is testing. It is leaning against the wind. It tests the market’s determination to change rates. If the RBA has a range in mind for the value of the RBA against other currencies, it may try to oppose a change in the market for FX.


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Foreign Exchange Market ops In the end, the wind might win, and, once it

is clear that the markets are serious about their perception of the value of the AUD in terms of other money, there is nothing that the RBA can do, and operations will cease.

An example of the latter type of operation was when the AUD hit a low against the USD of USD 0.47/AUD.


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Foreign Exchange Market ops The RBA thought that it was oversold

versus the fundamentals of the domestic economy, and they engaged in operations to support and boost the price.

The result was that the AUD eventually moved back to the USD 0.52 level, about 10 % higher.


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Foreign Exchange Market ops Eventually, the AUD got to where it is

now, in 2007, to the USD 0.70-0.80 range, several years after 2001.

In these types of operations, central banks usually try to keep it secret that they are in the markets, as information of that sort could affect the markets.


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Beyond the Book


Sterilization If the central bank acts in the foreign

exchange markets, it could affect interest rates in the domestic market.

Thus, the idea of sterilized intervention has come about. For example, if the bank buys foreign currency, it puts more AUD into the system.

The increased supply of money could act to lower interest rates.

(C) Red Hill Capital Corp., Delaware, USA 2008 80

Sterilization To counterbalance the effect on the money

supply, arising from the its transactions in the FX markets, the RBA can do the opposite in its open market operations.

In the example above, it would counteract by selling bonds and take cash out of the system, in an amount equal to the amount it put into the system in its FX operations.

Such counterbalancing is referred to as sterilization.


Targets & Instruments Monetary policy is necessary, a priori, but

it has evolved beyond the basic need and has experimented in different forms to affect different things.

The objectives of monetary policy, e.g., lower inflation, lower unemployment, higher growth, lower current account deficit, or the value of the currency vis-à-vis others, are commonly referred to as targets of policy.


Targets & Instruments In turn, the central bank tries to achieve its

targets by fixing the values of some economic variables that are within its control and that will have an affect on the targets.

Those variables are called instruments of policy.

Logic tells us that we will need a number of instruments at least equal to the number of targets that we want to affect.


Targets & Instruments The two variables that the central bank can

try to set are interest rates or the growth of money aggregates.

If we set interest rates, we lose control of the money aggregates (MS is perfectly elastic). If we control the aggregates, we lose control of the interest rate (MS vertical).

While the central bank has full control over interest rates, it does not have full control over the growth of money aggregates: it is unwieldy.


Targets & Instruments In fact, money aggregates can be

regarded as intermediate targets. The value of intermediate targets is that

information about them becomes available before information about the ultimate targets (they are, effectively, leading indicators).

The current manner in which the RBA implements its policy is indirect control of interest rates.


Targets & Instruments Effectively, it is taking a step back away from

interest rates as instruments and making them, instead, intermediate targets.

Thus, the RBA announces a target rate for the overnight interbank market, providing advance information about its intentions for rates.

That also tells that markets that, if they do not do it themselves, the RBA will act to impose discipline through its open market and FX operations.


Epilogue Since money is just paper, and, technically, a

government could print as much as it pleases, there has to be some sort of control over the production and supply of money.

Although it is easy to fool people, people are not so gullible as to not react to changes in the supply of paper money.

For example, if the money in circulation was $1 billion yesterday, and it is, suddenly, $2 billion, today, people will value it as half as much as yesterday.

87(C) Red Hill Capital Corp.,

Delaware, USA 2008

Epilogue What they will do is adjust prices of

everything to double what they were yesterday.

Thus, along with paper money, there must be some sort of control over the supply of that money, which means that there is a need for some sort of monetary policy.

Indeed, it is a difficult task to have enough, but not too much, money in circulation to satisfy the various demands for money, for transactions and investment purposes.


Delaware, USA 2008

Epilogue Too little money will hinder the processes of

the economy. Too much money will allow for an undue

amount of marginal and speculative economic activity.

The proposition becomes even more complicated because money has velocity, so the amount of money needed in the system is some fraction of the total transactional needs of the economy.


Delaware, USA 2008

Epilogue Trying to actually control the supply of

money, as was attempted in the 1970’s, was a failed experiment.

We have even seen that monetarists argue that little should be done beyond a once a year announced target.

Financial innovation and deregulation since the 1980’s has caused the money multiplier to change, substantially, while floating currencies and free flow of funds across national borders have allowed the monies of different countries to rationalize one another.


Delaware, USA 2008

Epilogue Thus, monetary policy has evolved into

adjusting interest rates to affect the demand for money. Thus, it has been limited to the use of one instrument.

It is carried out through the use of intermediate target interest rates.

In addition, in Australia, the ultimate target has also been limited to only one: to keep inflation under control to add stability to the economy.


Delaware, USA 2008

Ask Yourself1. If the RBA wants interest rates to be

exactly equal to one number, e.g., 4%, what will the MS curve look like?

2. If, suddenly, the RBA decreases MS from one quantity at any price to a lesser quantity at any price, a shortage of money will exist. What process and ending will ensue?

3. What are smoothing and testing and why are they done?


Delaware, USA 2008

Ask Yourself4. If money can get around an economy, on

average, four times a year, and nominal GDP is $10 billion, what is the money supply, according to classical thinking?

5. Can you explain, in your own example, why we say that monetary policy is a blunt instrument?

6. Can you explain the differences between monetary policy transmission according the Keynesians and Monetarists, using both words and graphs?


Delaware, USA 2008

Exam-caliber Questions1. Critically analyse the following statement: “With

inflation high and the economy growing strongly, the Reserve Bank of Australia has little choice, but to increase the interest rate”.

2. If nominal GDP of a country is $4 billion, explain why the monetary base can be much less than $4 billion of money in circulation.

3. Critically analyse the following statement: “There are two instruments for implementing money policy: controlling interest rates and money aggregates: if interest rates, MS must be totally elastic; if aggregates, MS must be perfectly inelastic.”


Delaware, USA 2008

95

Homework

Chapter 16 All problems All multiple choice


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Next week Final lecture: Fiscal Policy Chapter 17.


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End


1 lecture 11 mod 6.1: monetary policy c.l. mattoli (c) red hill capital corp., delaware, usa 2008

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