mon_econ_week9 - The University of Sydney Faculty of...

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The University of Sydney Faculty of Economics and Business MONETARY ECONOMICS {6 credit points} ECOS3010 — 2009: S EMESTER 2 Tony Aspromourgos WEEK IX 9.1 IS–LM with interest-setting monetary policy 9.2 sources of interest-elasticity of aggregate expenditures 9.3 ‘neutrality’ of money 9.4 the Phillips Curve framework, rational expectations & PIP 9.5 endogenous money, interest setting & the transmission mechanism READING: M.K. Lewis & P.D. Mizen (2000) Monetary Economics , Oxford: Oxford University Press; ch. 14 (‘Monetary Policy in Practice’: 342–70). Preliminary Comments. The ‘transmission mechanism’ commonly is defined in terms of the various channels via which monetary policy may be capable of influencing the private sector decisions which ultimately determine aggregate expenditures on the output of the domestic economy. More fully, one may define it as the set or sequence of causal connections running from the choice of policy instruments by the monetary authority (hereafter, CB), through to the possible ways in which use of the instrument(s) affects the ultimate objective(s) of the CB . The question of what objectives monetary policy can and should pursue is considered further in weeks 10–11. Here, we simply take as given, the conventional policy objective commonly chosen by CBs in the contemporary world: a ‘low’ inflation rate (over some time horizon). The question of instrument choice has been considered in earlier weeks, and will, finally, be considered again, also in weeks 10–11. In any case, the upshot of earlier discussion is already clear enough: the instrument of choice by central banks is setting a very short rate of interest, day-to-day – with the private sector’s net demand for additional outside money accommodated by the monetary authority. The alternative option of choosing as the instrument of policy, exogenous setting of (changes in) the quantity of outside money – ‘monetary targeting’ (as it came to be known in the era of monetarist ascendancy) – is rejected, and is in any case, not practicably available (more on the latter point, in weeks 10–11). Furthermore, financial deregulation since the 1980s means that interest-rate setting is virtually the only instrument of monetary policy.* NOTE * However, prudential regulation , insofar as it influences the balance sheets of financial intermediaries, may be conceived of as another distinct instrument of policy; but this is not generally thought of as directly pertinent to the macroeconomic objectives of monetary policy; it is rather aimed at financial system stability. 9.1 IS-LM with interest-setting monetary policy If one approaches the question of how monetary policy influences aggregate expenditures in the conventional framework of the IS-LM determination of aggregate demand – but with interest- setting rather than quantity-setting monetary policy – then a simple representation of the change
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mon_econ_week9 - The University of Sydney Faculty of...

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