chap020 - Chapter 20 Money Growth, Money Demand, and Modern...

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Chapter 20 Money Growth, Money Demand, and Modern Monetary Policy Chapter Overview In contrast with the United States, money plays a central role in the formulation of European monetary policy. What accounts for the difference? In this chapter we will examine the link between money growth and inflation (to clarify the role of money in monetary policy) and explain the logic underlying central bankers’ focus on interest rates. Reading this chapter will prepare students to: assess the correlation between money growth and inflation; differentiate among the different components of money demand; and explain why volatility in the demand for money has led the Federal Reserve to focus more on interest rates in formulating monetary policy. Important Points of the Chapter Even though most of the discussion about monetary policy these days seems to focus on interest rates and exchange rates, central bankers do care about money. Most economists agree with Milton Friedman that, “inflation is always and everywhere a monetary phenomenon.” In contrast with the United States, money plays a central role in the formulation of European monetary policy. The ECB’s monthly announcements of its target interest rate have always mentioned money growth, whereas since July 2000 the FOMC stopped publishing target ranges for the monetary aggregates, saying that they no longer provided “useful benchmarks for monetary policy.” Application of Core Principles Principle #5: Stability (page 491) The higher the rate of money growth, the higher inflation is likely to be. Thus, to avoid sustained episodes of high inflation, a central bank must be concerned with money growth. Principle #4: Markets (page 491) Changes in velocity can be linked to interest rates and to innovations in financial markets, such as the introduction of stock and bond mutual funds that allowed checking privileges in the late 1970s and early 1980s. Principle #1: Time (page 493) The higher the nominal interest rate, the less money individuals will hold. Principle #2: Risk (page 496) Changes in the riskiness of other assets will affect the demand for money. Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets 30
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Chapter 20 Money Growth, Money Demand, and Modern Monetary Policy Principle #5: Stability (page 504) By keeping interest rates stable, policymakers can insulate the real economy from disturbances that arise in the financial system. Teaching Tips/Student Stumbling Blocks The material in this chapter lays the groundwork for the presentation of the new approach to macroeconomics that is explored in Chapters 21 and 22. The purpose of this chapter is to get the student to the point where he or she realizes why modern central banks focus on interest rate control. The primary focus in chapter 20 is on Core Principle 5, which states that stability
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This note was uploaded on 02/12/2012 for the course ECON 101 taught by Professor Abrams during the Spring '11 term at Adams State University.

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chap020 - Chapter 20 Money Growth, Money Demand, and Modern...

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