Instructor16Commentary - 1 INSTRUCTOR COMMENTARY Chapter...

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

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.