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lectur4 - MONETARY POLICY Federal Reserve(Central Bank...

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1 MONETARY POLICY Federal Reserve (Central Bank) controls money supply .
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2 MONETARY POLICY The money supply can/does influence price levels Inflation occurs if the money supply increases, ceteris paribus. Deflation occurs if the money supply decreases, ceteris paribus.
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3 Dollar NOT backed by gold! 1)Up until 1935, citizens could redeem $ in gold @ a rate of $20.67 per ounce. 2)From 1935 to 1968, the US redeemed $ held by foreigners only, @ a rate of $35 an ounce.
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4 Dollar NOT backed by gold! 3)From 1968 to 1971 there was only selective foreign redemption. 4)1971 "Gold Window" closed!
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5 Dollar NOT backed by gold! Dollar is only backed by "Faith," the fact most people "want it," and not enough $ floating around out there such that everybody can have all they want!
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6 What if you stuff your money in a mattress? What does it cost you? Zero Inflation? 10% Inflation? Known as the opportunity cost of holding money!
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7 Interest The price you pay for using someone else's money (accounting cost or explicit cost) OR holding your own money as cash. (opportunity cost or implicit cost)
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8 Interest Nominal interest rates (market rates) Real interest rates A return net of inflation and risk premium Risk-Free interest rates Government treasury securities, no risk premium.
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9 Interest Nominal Interest Rate = real interest rate + compensation for inflation + default risk premium
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1 Real Interest Rate The real interest rate is the price of money, net of inflation and risk, that people are willing to accept for deferring present consumption until some future time period $1 in your hand right now is worth more than the promise (without risk) of $1 in your hand a year from now.
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