A Monetary Intertemporal Model: Money, Prices,
and Monetary Policy
Analysis of a monetary economy can become quite complex. Modern economies require significant
specialization to function well. Such specialization requires a commonly accepted medium of exchange.
Money serves this function. Although it matters quite a lot that we have money, the actual quantity of
money in circulation is not very important. This fact emerges because the quantity of money is neutral, if
not in the very short run, certainly in the long run.
In the monetary intertemporal model, changes in the money supply affect the level of prices, but do not
otherwise affect economic outcomes; money is neutral. Real factors may also affect the price level. The
price level adjusts to keep money demand and money equal. Disturbances that change the equilibrium
levels of output and the real interest rate therefore change the price level. Shifts in preferences for money
holding also affect the price level.
The principle role of monetary policy in the monetary intertemporal model is to control the level of prices.
A popular goal of policy is to stabilize the price level in response to shocks to the economy. However, the
central bank’s ability to stabilize prices may be compromised if money demand does not behave in a
predictable manner. It is also important for policy to set targets and adhere to particular policy rules.
Classroom Discussion Topics
The payments technology has continually advanced over time, but the rate of advance has accelerated
in the era of computer technology. Ask the students for examples of advances in this technology beyond
the routine use of cash and the writing of paper checks. Some obvious possibilities include the use of
ATMs, computer and telephone banking, the use of prepaid phone cards and other forms of smart
card technologies. Students are also likely to discuss the existence of credit cards and the ever more
sophisticated ways to use credit cards and protect against fraud. As one example, there is the use of credit
cards to pay for purchases over the Internet. In discussing these possibilities, it is also important to
distinguish the payments technology from the proper measurement of the money supply. For example, it
is important to distinguish between payment arrangements that are uses of credit, like the use of credit
cards, from uses of money, like cash and transaction deposits.
Standard macroeconomic analysis, like that of this chapter, emphasizes central banks’ control of the
quantity of money in circulation. However, most contemporary discussions of U.S. monetary policy
focus on the Federal Reserve’s control of “interest rates.” This chapter offers plenty of opportunities to
discuss real life events. For example, discuss the upcoming meeting of the FOMC, what it decides on,
what information it uses, and what it may do.