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Lesson 8--Money and the Economy

# Lesson 8--Money and the Economy - Lesson 8 Money and the...

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Lesson 8: Money and the Economy Chapter 18--M&B   Section on Money-Growth Rules (p392-394)   Milton and Money Stock Control, William Poole (FRBSL July 30, 2007) http://www.stls.frb.org/news/speeches/2007/07_31_07.html

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Any Idea Why M1 surged in the fall of 2008?
M2 surged in the aftermath of the Lehman bankruptcy— Why?

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Money Supply Growth and The Business Cycle

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Money-Growth Rules Money-Growth Rules The first type of rule proposed by The first type of rule proposed by monetarists in 1960s was the monetarists in 1960s was the money-growth rule money-growth rule A A money growth rule money growth rule focuses only on focuses only on the growth rate of money in the long the growth rate of money in the long run, ignoring short-run fluctuations run, ignoring short-run fluctuations Example Example : money growth = 3% every : money growth = 3% every year year Such a rule is based on the equation Such a rule is based on the equation of exchange of exchange
The Equation of Exchange The Equation of Exchange The The equation of exchange equation of exchange is based on is based on idea that the money in circulation idea that the money in circulation must be used a certain number of must be used a certain number of times to support a given amount of times to support a given amount of spending spending ×   ×   V = P  V = P  ×   ×   Y Y Velocity Velocity = number of times the = number of times the average dollar is spent on final goods average dollar is spent on final goods and services and services

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Money-Growth Targets Money-Growth Targets % M M + % + V V = % = % P P + % + % Y Y = = π π + % + % Y Y Money growth + velocity growth = inflation rate + output growth Money growth + velocity growth = inflation rate + output growth Monetarists believe velocity is stable or at Monetarists believe velocity is stable or at least predictable least predictable % % Δ Δ M M = = π π T T + % + % Δ Δ Y*    Y*    % % Δ Δ V V e e π π T = inflation target = inflation target % % Δ Δ Y* =  Y* =  growth rate of potential output growth rate of potential output % % Δ Δ V V = expected growth rate of velocity = expected growth rate of velocity
Instability of Money-Growth Rule Instability of Money-Growth Rule Financial innovations sometimes Financial innovations sometimes alter the relationship between money alter the relationship between money and other variables, such as the and other variables, such as the introduction of interest-bearing introduction of interest-bearing checking accounts checking accounts As a result, velocity has become As a result, velocity has become unstable in the 1980s and 1990s.

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