DSST Money & Banking Part 1

Non classical macro theories incorporating rational

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Non Classical Macro Theories incorporating Rational Expectations:  Critical assumption that separates New  Classical Theory from others is that wages and prices are fully flexible in the short run as well as the long run Long term contracts exist:  Change in market conditions that would call for a different wage or price structure  are not put into effect until contracts are renegotiated. Efficiency Wages:  (Wages that maximize profit) exist because a wage reduction may lower rather than increase  firms profits if it reduces employee morale and labor productivity. Menu Costs exist that make it unprofitable to change prices quickly. Nonmarket Transaction : Not 'valued' in the calculation of GDP. Examples would be cleaning your own home or  hiring an illegal person to work for you. Monetary Policy History: 1913-1929 Formation of the FED and the REAL Bills Doctrine: Real Bills Doctrine:  The loans given to commercial borrowers under the real bills theory were  considered to be  self-liquidating . The FED should satisfy any request for it to discount loans to  commercial banks as long as it discounted “real bills” or short term loans to business for “productive 
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purposes” such as inventory loans.  This concept was shown to be a poor rule for commercial bank  portfolio decisions, and an even worse base for monetary policy due its  procyclical impact. Procyclical : Money supply will rise during economic expansion and fall during recession--which is the  opposite of what we need. 1929-1939 Great Depression:  Crash occurred in October of 1929 and the recession lasted until early 1933.   FED  adhered to the Real Bills Doctrine instead of using Open Market Operations and many historians believe that this  helped to extend the recession. 1940-1951 World War II and Treasury Dominance : FED policy during this period was to stabilize interest rates  at low levels in order to support Treasury financing operations by standing ready to buy and sell Treasury  obligations at a fixed set of prices, the FED reduced investor’s fears of capital losses, and made them more willing  to invest in government debt instruments. 1951  –  1970 Money Market Strategies:  In Mach 1951, FED was concerned about inflation associated with  pegging interest rates, and culminated in the “ Accord ” – an agreement in which the fixed interest rate targets  (“ pegging” would be eliminated ) but the FED would not allow rapid rises in rates to occur.
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