Chapter 13

Chapter 13 - Chapter 13: Modern Macroeconomics and Monetary...

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Chapter 13: Modern Macroeconomics and Monetary Policy Prior to the 1970s, most economists thought fiscal policy was far more important than monetary policy. See opening quote, page 327. Fiscal policy is based on the illusion that you can confiscate the wealth/income of one group of people and give it to another group of people, and raise the standard of living of everybody. "Redistribution creates wealth." Now the consensus is that monetary policy is more important than fiscal policy. Current expansion is far more because of stable monetary policy than any fiscal stimulus. In fact, Bush and Clinton both RAISED taxes. We now look at how monetary policy works - how changes in monetary policy/MS affect int rates, output, ex-rates and prices. DEMAND FOR MONEY Money as cash or non-interest checking. MD is the amount of cash/checking that people/businesses are willing to hold at any given time. MD is inversely related to the Interest Rate - think of Int Rate as the Int Rate on bonds or savings or CDs. Int rate if the Opp Cost of holding cash balances. If you weren't holding cash, you could be getting interest by buying a bond, CD or putting cash into a svgs. acct. MD is positively related to income (GDP) and negatively related to int rates. As income rises, the MD for transactions, emergencies, and speculation increases. If your income doubled, your MD would increase. As int rates rise, the opp cost of holding money increases, so people would minimize MD during periods of high int rates. Example: Tbills were 15.5% in 1981. MD is also influenced by technology/innovation. Examples: credit cards and ATM machines allow us to carry less cash, reduces MD. Int on checking would increase MD. Also, income is more predictable now compared to 100 yrs. ago when the economy was more farm-based. Income was received two or three times a year and the timing and the amount was unpredictable. MS is fixed/determined by the FRS, and is independent of the interest rate, so it is shown as a vertical line on page 329.
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How does monetary policy influence the price level and output? Start with the Quantity Theory of Money. Developed in the early 1900s by economist Irving Fisher. Equation: PY = GDP = MV, where P = price level Y = real output PY = nominal GDP M = MS/M1 V = velocity or turnover rate of money. The average number of times a dollar is used during the year to purchase final goods/services. In 1995, GDP was $7,246B, M1 was $1.125B, M2 was $3,660B. Velocity of M1 was 6.4 times and Velocity of M2 was 2x. Velocity = GDP/M1. V is inversely related to MD. If people hold less cash and GDP is the same, then velocity is greater. Velocity increases as technology increases - more efficient financial/banking system - faster check clearing, etc. Also as we use credit cards, ATMs, MD is lower, V is higher. We can get by with less cash, as Velocity increases, and money circulates faster. V has generally been increasing as we move towards a cashless economy. Convert to percentage changes, we get the Equation of Exchange:
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This note was uploaded on 11/18/2011 for the course ECON 101 taught by Professor Gottlieb during the Fall '08 term at Rutgers.

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Chapter 13 - Chapter 13: Modern Macroeconomics and Monetary...

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