AB204 Unit 8 Seminar Chapter 15 Monetary Policy

 The money demand curve arises from a trade-off between the opportunity cost of holding money and the liquidity that money provides.  The opportunity cost of holding money depends on short-term interest rates, not long-term interest rates. Chapter 15

Other things equal, the nominal quantity of money demanded is proportional to the aggregate price level. So money demand can also be represented using the real money demand curve. Changes in real aggregate spending, technology, and institutions shift the real and nominal money demand curves. According to the quantity equation, the real quantity of money demanded is proportional to real aggregate spending, where the constant of proportionality is one over the velocity of money According to the quantity equation, the real quantity of money demanded is proportional to real aggregate spending, where the constant of proportionality is one over the velocity of money. Chapter 15

The liquidity preference model of the interest rate says that the interest rate is determined in the money market by the money demand curve and the money supply curve. The Federal Reserve can change the interest rate in the short run by shifting the money supply curve. In practice, the Fed uses open-market operations to achieve a target federal funds rate, which other interest rates generally track. Chapter 15

Expansionary monetary policy, which reduces the interest rate and increases aggregate demand by increasing the money supply, is used to close recessionary gaps. Contractionary monetary policy, which increases the interest rate and reduces aggregate demand by decreasing the money supply, is used to close inflationary gaps. Chapter 15

Like fiscal policy, monetary policy has a multiplier effect, because changes in the interest rate lead to changes in consumer spending and savings as well as investment spending. In the short run, a change in the equilibrium interest rate determined in the money market results in a change in real GDP and in savings through the multiplier effect. The change in savings shifts the supply of loanable funds in the market for loanable funds until it reaches equilibrium at the new equilibrium interest rate. Chapter 15

In the long run, changes in the money supply affect the aggregate price level but not real GDP or the interest rate. In fact, there is monetary neutrality: changes in the money supply have no real effect on the economy in the long run. So monetary policy is ineffectual in the long run. Chapter 15

In the long run, the equilibrium interest rate matches the supply and demand for loanable funds that arise at potential output in the market for loanable funds. Chapter 15

Chapter 15 conclusion This concludes our coverage of key points from Chapter 15 This concludes our coverage of key points from Chapter 15 Are there any questions? Are there any questions?