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Instructor16Commentary - 1 INSTRUCTOR COMMENTARY Chapter...

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INSTRUCTOR COMMENTARY Chapter Reference: Chapter 16 (Please Note: The Appendix to Chapter 16 will be Covered in conjunction with Chapter 17) Monetary Policy 1. Chapter 16 focuses on the following important topics: A. The goals of monetary policy. In Keynesian macroeconomic theory, the primary goal of monetary policy is to achieve the optimum balance between the level of real GDP (and employment) and the overall price level. Because the AS schedule is upward-sloping in the “intermediate” range, shifts of the AD schedule caused by changes in the money supply should account for both the desirable effects of raising real GDP (and employment) and the undesirable effects of increasing the overall price level. According to Monetarists, the goal of monetary policy should be to accommodate the growth rate of real GDP by adopting a “money supply rule” that would cause the money supply to grow at the same rate of growth predicted for real GDP so that the price level will remain constant. Keynesians advocate “short-run” goals for monetary policy, while Monetarists advocate longer-run goals. (text, pp. 381, 403-404) B. The tools of monetary policy. The tools of monetary policy are changes in the legal reserve requirement, open market operations and changes in the discount rate. Each type of policy changes the overall supply of money in the economy by predictable amounts. Both Keynesians and Monetarists believe that the money supply should be controlled by the FED, and both groups advocate that the same tools be used to accomplish this goal. As noted above, however, these groups differ as to the goals of monetary policy and therefore would use these tools in different ways. Keynesians would advocate the use of both monetary and fiscal policies to achieve “short-run” stabilization goals along the “intermediate” range of the AS schedule. Monetarists would focus on stabilizing the price level as economic growth occurred, with little or no emphasis placed on short-run stabilization policies. (text, Chapter 15, pp. 382-388) C. The demand for money. 1
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The demand for money function is based on the concept that households and business firms may hold their wealth (net worth) in a variety of forms, one of which is in the form of money. Keynesians emphasize that two components of the demand for money, the transactions demand M(t) and the Precautionary demand M(p) are positively related to the level of nominal GDP and that the third component—the speculative demand (M(s)--is inversely related to the rate of interest. Monetarists deny the importance of the speculative demand for money and believe that a stable (and/or predictable) relationship—called the Velocity of money—exists between the demand for money and nominal GDP. The important differences in Keynesian vs. Monetarist theories of the demand for money give rise to very different views about how changes in the money supply affect the level of nominal GDP.
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