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325_Lecture18_April6

325_Lecture18_April6 - MONEY AND BONDS APRIL 6 2011...

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1 M ONEY AND B ONDS A PRIL 6, 2011 April 6, 2011 2 I S M ONETARY P OLICY N EUTRAL? Introduction An enduring question in macroeconomics: does monetary policy have any important effects on the real (i.e, real GDP, consumption, etc) economy? Definition : Money (and hence monetary policy) is neutral if changes in the money supply (i.e., changes in monetary policy) have no effect on the real economy Monetary policy is non-neutral if it does have effects on the real economy New Keynesian view: money is non-neutral (because prices are rigid/sticky, often for long periods of time) RBC view: money is neutral (because prices are not rigid/sticky in any important way) To seriously study neutrality issue, need to finally explicitly think about money and monetary policy It’s only been in the background of the analysis so far…
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2 April 6, 2011 3 T HE R OLES OF M ONEY Macro Fundamentals The roles played by money Medium of exchange Eases double-coincidence of wants problem Unit of account A common “language” for all prices to be quoted in Store of value Apples will perish in short amount of time, dollar bills won’t How to conceptually “model” money a surprisingly hard problem Much more difficult than, i.e., “consumption-leisure framework” or “consumption-savings framework” How to formally (mathematically) represent these roles of money? A shortcut: suppose money directly yields utility Period- t utility function Money-in-the-utility-function (MIU) formulation IMPORTANT: It’s not M t in the utility function, but rather M t / P t , t t t M c P u § · ¨ ¸ © ¹ April 6, 2011 4 R EAL M ONEY B ALANCES Macro Fundamentals M t / P t a key variable for macroeconomic analysis Unit Analysis (i.e., analyze algebraic units of variables) Units( M t ) = $ Units( P t ) = $/unit of consumption Units( M t / P t ) = $ unit of consumption $ $ $ unit of consumption unit of consumption
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3 April 6, 2011 5 R EAL M ONEY B ALANCES Macro Fundamentals M t / P t a key variable for macroeconomic analysis Unit Analysis (i.e., analyze algebraic units of variables) Units( M t ) = $ Units( P t ) = $/unit of consumption Units( M t / P t ) = Utility (composite of medium of exchange, unit of account, store of value) depends on real money ( M / P ), not nominal money ( M) Measures the purchasing power of (nominal) money holdings… …which is presumably what people most care about M t and P t can potentially grow at different rates In which case real money balances change from one period to the next $ unit of consumption $ $ $ unit of consumption unit of consumption April 6, 2011 6 M ONEY M ARKETS AND B OND M ARKETS Macro Fundamentals A prerequisite for analyzing monetary policy: understanding bonds and bond markets Bond markets and money markets tightly linked to each other What is a “bond?”
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