1. Monetary Policy
A brief introduction

2. Monetary Policy
Monetary policy is the manipulation of the money supply and interest rate by the central bank to influence the borrowing of money and thereby the level of AD (via C and I)
What is:
Central bank?
Money?
Any medium that is acceptable as payment for goods and services
Interest rate?
It is the price/cost of borrowing money which depends on length of time of borrowing, size of loan, inflation rate, etc. (risk and uncertainty involved with time)
The interest rate is determined using the usual Demand and Supply for money OR the loanable funds market

3. Nature of work of financial analysts and central bank officials

4. How interest rate affects AD
Changes in interest rates ultimately affect two of the four components of aggregate demand
Investment (I): e.g. building a new factory, purchasing a very expensive inventory and machine that will likely to increase future production
Consumption (C): e.g. large purchases that require borrowing like cars, university tuition, etc.
Because cost of borrowing less and/or less worthwhile to save or to put profits into savings
BUT how interest-sensitive (elastic) is investment?

5. Increasing the MONEY SUPPLY
Quantitative Easing and ways of influencing amount of lending done by BANKS
Equation: MV ≡ PT (or PQ or PY or Nominal GDP)
SO will an increase in M increase in P?
YES if…………………………………………………
 MONETARIST view : Money is so “dangerous” that central bank should only allow it to grow at……………………………………………..

6. Monetary base rises to record ¥404.5 tril. Sept 3rd 2016
Jiji PressTOKYO (Jiji Press) — Japan’s monetary base at the end of August increased 0.1 percent from a month before to ¥ trillion, hitting a record high for the ninth straight month, the Bank of Japan said Friday.
The growth came as the central bank continues to supply massive funds under its ultraeasy monetary policy.
The monetary base is the combined balance of currency in circulation and commercial financial institutions’ current account deposits at the BOJ.
Year on year, the monetary base was up 23.5 percent, the BOJ said.

7. Monetary base in Japan

9. But all have weaknesses………
Three Models
But all have weaknesses………

10. Equilibrium Interest Rate and Money Supply

11. Loanable Funds Market

12. Investment

13. Short Term Interest Rate………..

14. Which D-side policy is more effective?
Fiscal Policy
Pro: can pull economy out of recession (e.g. Great Depression of the 1930s; after 2008)
ability to target sectors (e.g. spending on education, infrastructure) with some supply side effects
Con: time lags; hard to forecast and calculate the impacts of changes; hard to target and fine tune as AD determined by multiple factors;
Budget deficit if expansionary  risk of crowding out (though has not happened in Japan)
Monetary Policy
Pro: quick implementation; independence from political constraints; no crowding out; can adjust interest rate incrementally and flexibly
Con: time lags; effective if an inflationary gap, but not so during recession (pushing on a string) ; international impacts (effects on exchange rates, access to foreign lending);

15. Summary of D-Side Macro policies
It is difficult to achieve the desired macro-economic outcomes. One intervention has multiple/multivariate channels & mechanisms in affecting the various demand components and human behavior is complex and dynamic
During the 1980s a lots of economists studied macroeconomic dynamics and management . But inflation/deflation, unemployment, inconsistent GDP growth persist
Moreover, financial crises on the scale of the 1930s Great Depression continue to happen eg the recession after the Lehman Shock
The two schools of thought
Quite different on the implications on price and real GDP level (monetarists/new classical believe expansionary policies have no effect on real GDP, only on average prices)
We considered only the Demand Side, also need to consider
Supply Side Policies
But first will study UNEMPLOYMENT & INFLATION in more depth