The Money Market & Monetary Policy Part II AP Macroeconomics

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Presentation transcript:

The Money Market & Monetary Policy Part II AP Macroeconomics

Where did we come from? In a previous lesson, we brought together the demand for and supply of money in the money market.

Where are we going? In this lesson, we’ll relate monetary policy to changes in the monetary variables such as the federal funds rate, the money supply, and velocity.

Just an FYI… Here’s a resource that lays it out, plain and simple, about monetary policy (and the Fed) in general: In Plain English: Making Sense of the Federal Reserve: onetary_policy.htm onetary_policy.htm

How does the Fed control the interest rate? Given the demand for money, by controlling the money supply, the Federal Reserve controls the interest rate in the short run. As we know, the interest rate affects the level of investment and a portion of the level of consumption.

The Money Market, investment, and aggregate demand… Visual 4.4, Unit 4 Macroeconomics An increase in the MS (MS to MS1) causes the interest rate to decrease (r1 to r) and investment (I to I1) and consumption to increases. In turn, we see that AD increases from AD to AD1.

What if? Draw it out. What do you suppose would happen to interest rates if the Federal Reserve decided to increase the money supply? What do you suppose would happen to interest rates if the Federal Reserve decided to decrease the money supply?

What if? Answers. What do you suppose would happen if the Federal Reserve decided to increase the money supply?  Interest rates would decrease. This is a good prescription for deflation (inflation involves an increase in the MS). What do you suppose would happen if the Federal Reserve decided to decrease the money supply?  Interest rates would increase. This is a good prescription for inflation (deflation involves a decrease in the MS).

Factors affecting income velocity… Income velocity: average # of times $1 is spent on final goods and services within a given time frame (usually a year). So what might cause income velocity to change?  Institutional changes (how money is transferred)  Changes in interest rates  Changes in the price level

And now… Some resources: Monetary policy and the Fed: olicy.htm Reffonomics: Morton workbook: Activity 40.

Works Cited Economics of Seinfeld. Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers. Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3 rd ed. New York: National Council on Economic Education, Print. Reffonomics.