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Econ 201, Week 15 (Monetary Policy)

by: Ekene Tharpe

Econ 201, Week 15 (Monetary Policy) ECON 201

Marketplace > University of Tennessee - Knoxville > Economcs > ECON 201 > Econ 201 Week 15 Monetary Policy
Ekene Tharpe

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About this Document

Covers all aspects of week 15 notes. Includes all information on monetary policy.
Intro Economics: Survey Course
Donna Bueckman
Class Notes
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This 5 page Class Notes was uploaded by Ekene Tharpe on Monday May 2, 2016. The Class Notes belongs to ECON 201 at University of Tennessee - Knoxville taught by Donna Bueckman in Fall 2015. Since its upload, it has received 16 views. For similar materials see Intro Economics: Survey Course in Economcs at University of Tennessee - Knoxville.


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Date Created: 05/02/16
Econ  201:  Week  15     2  Big  AD  Shifts   1. The  Great  Depression    (1929-­‐1933)   • Money  supply  falls  28%  because  of  banking  system  problems   • Stock  market  prices  fall  90%:    C  and  I  reduce   • Y  fell  27%   • P  fell  22%   2. The  World  War  II  Boom  (1939-­‐1944)   • G  rose  from  $9.1  bil  to  $91.3  bil   • Y  rose  90%   • P  rose  20%   SRAS 2   • U  fell  from  17%  to  1%   LRAS     SRAS 1   Economic  Fluctuations  (4  steps):  Event-­‐  oil  prices  rise   B   1. Increase  costs,  SRAS  shifts   P 2   2. SRAS  shift  left   P 1   3. SR  eqm  at  point  B.     A   a. P  higher,  Y  lower,  U  higher     From  A  to  B:  Stagfication-­‐  period  of  falling  output  and  rising  prices       Y 2               N   Accommodations  and  Adverse  Shift  in  SRAS   • Policy  makers  do  nothing:   o U  =  lower  wages   o SRAS  shift  right  until  LR  eqm  at  A   • Policy  makers  make  policy   o Increase  AD  and  accommodate  the  AS  shift  (Keynes)   o Y  back  to  YN,    P  permanently  higher       1970s  Oil  Stock  and  Their  Effects       1973-­‐75   1978-­‐80   Real  Oil  Price   +138%   +99%   CPI   +21%   +26%   Real  GDP   -­‐.7%   +2.9%   #  Unemployed   +3.5  mil   +1.4  mil   Suggests  accommodations     Case  Study:  08-­‐09  Recession   • Dec.  2007-­‐  June  2009:  real  GDP  fell  4%   • Housing  market  played  central  role   • Policy  response:   o Fed  Reserve  buys  mortgage-­‐backed  securities  and  other  private  loans   o US  treasury  injects  capital  into  banking  system:  increases  bank   liquidity;  hope  to  start  ‘credit  crunch’   o Fiscal  policymaker  increased  govt  spending  and  reduce  taxes  by  $800   billion     John  Maynard  Keynes:  1883-­‐1996   • General  Theory  of  Employment,  Interest,  and  Money  (1936)   o Argues  depression  and  recession  can  result  from  inadequate  demand     o Policy  makers  should  shift  AD       The  Influence  of  Monetary  Policy   • Monetary  policy:  setting  of  money  supply  by  policy  makers  in  the  central   bank   o Expansionary:  get  $$  into  economy   o Contractionary:  take  $$  from  economy     • Central  bank:  institution  that  oversees  the  banking  system  and  regulates  the   money  supply     Who’s  in  Charge?   • Federal  Reserve  (Fed):   o Central  bank  of  the  US   o Conduct  monetary  policy  (auctions)   • Dual  mandate:  Price  Stability  and  Maximum  Employment   o Supervise  banks   o Fiscal  agent  for  U.S  govt   o Processes  checks  and  electronic  payments   o Conduct  economic  research   o Lender  of  Last  Resort       Federal  Reserve  System:   • Board  of  governors-­‐  on  top   o 7  members;  in  Washington  DC   • 12  Regional  Fed  Banks-­‐  second   o located  around  U.S   • Federal  open  market  Committee  (FOMC)   o Includes  board  of  governors  and  presidents  of  some  regional  Fed   banks   o Decides  monetary  policy   Circular  Flow  of  Banking       Deposits:  Assets  of  public  liabilities     of  banks       Public     OMO   Fed   Discount  rate   Banks               Loans:  Assets  of  banks  liabilities  of  public             Monetary  Policy  Tools:     • Open-­‐Market  Operations/OMO:   o Purchase  and  sale  of  U.S  govt  securities  (T-­‐bills)  by  the  fed   § Expansionary:  purchase  securities   § Contractionary:  sell  securities   • Fed  loans:  make  loans  to  bank,  increasing  their  reserves   o Traditional  method:  adjust  the  Discount  Rate   § The  interest  rate  on  loans  the  Fed  makes  to  banks   o Federal  Funds  Rate:  interest  rate  banks  charge  each  other  for  loans;   rate  “set”  by  the  Fed   § Expansionary:  lower  rate   § Contractionary:  increase  rate   • Reserve  Requirement:  set  by  Fed   o Regulations  on  the  min  amount  of  reserves  banks  must  hold  against   deposits       *All  3  tools  create  excess  reserves  for  the  banks.  Allows  them  to  create  money   through  making  loans     Monetary  Policy  and  AD              M                              I          C     P        real  GDP              M                              I          C     P        real  GDP     a.)  Expansionary  monetary  policy   b.)  Contractionary  monetary  policy                                    get  $$  out  there/  liquidity  into  economy   • Problems  with  Controlling  Money  Supply:   o Households  could  hold  their  money  as  currency  and  not  put  in  the   banking  system   o If  banks  hold  more  reserves  than  required;  few  loans,  lower  money   supply   • Fed  compensates  for  households  and  bank  behavior     o Retains  ‘fairly’  precise  control  over  the  money  supply       Bank  Runs  and  Money  Supply   • 1929-­‐33  bank  runs  and  closings  cause  money  supply  to  fall  28%   • Fed  deposits  insurance,  help  prevent  bank  runs  in  the  U.S       A  New  Fed  Response:   • Quantitative  easing  (QE)   o Nov.  2008  (QE1)   o Buy  more  govt  securities  (LR)   o Buy  “toxic”  assets     The  Viscosity  of  Money   • The  number  of  transactions  in  which  the  average  dollar  is  used   • Notion:   o P    x    Y=  nominal  GDP  =  (price  level)  x  (real  GDP)   o M  =  money  supply   o V  =  Velocity     • Velocity  formula:   o V  =  (P    x    Y)/(M)   *Velocity  is  fairly  stable  over  time     Example  w/  one  good:  pizza  in  year  2006   • Y  =  real  GDP=3000  pizzas   • P  =  price  level=  price  of  pizza  =  $10   • P    x    Y  =  nom.  GDP=  value  of  pizzas  =  $30,000   o M  =  money  supply  =  $10,000   o V  =  Velocity=  $30,000/10,000  =  3   • The  avergage  dollar  was  used  in  3  transactions     The  Quantity  Equation  of  Money   • Multiply  both  sides  of  viscosity  formula  by  M:   o M  x  V  =  P  x  Y           5  steps  to  the  Quantity  Equation  of  Money:   1. Quantity  equation:  M  x  V  =  P  x  Y   2. Change  in  M  causes  nominal  GDP  (P  x  Y)  to  change  by  the  same  %   3. Change  in  M  doesn’t  affect  Y;  money  is  neutral   4. P  changes  the  same  percentage  as  P  x  Y  and  M   5. Fast  money  supply  growth  causes  rapid  inflation.  The  quantity  of  money   determines  its  value     Quantity:  The  Bottom  Line   The  Theory  of  money…   • If  real  GDP  is  constant,  then  inflation  =  money  growth  rate   • If  real  GDP  is  growing,  then  inflation  <  money  growth  rate   • Bottom  line:   o Ecomonic  growth  increases  the  number  of  transactions   o Some  money  growth  is  needed  for  the  extra  transactions   o Excessive  money  growth  causes  inflation     Example  with  one  good:  corn   • The  economy  has  enough  labor,  capital,  and  land  to  produce  Y  =  800  bushels   of  corn   • V  is  constant   • In  2008:  MS  =  $2000;  P  =  $5/bushels   • Compute  nominal  GDP  and  velocity  in  2008   o Nom  GDP  =  P  x  Y  =  $5  x  800  =  $4000   o Velocity  =  (P  x  Y)/(M)  =  (4000/2000)  =  2      


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