1. Monetary Policy
the expected effects of the FED’s
utilization of Monetary Policy to
facilitate the economy’s growth
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2. The Price Level is determined by:
The relationship between
the amount of money in
circulation and the amount
of goods and services in the
economy. Remember:
MV = PQ
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3. the Equation of Exchange
MV = PQ
where: M is defined to be the money supply ~ currency +
demand deposits + travelers’ checks = money since these items are
used as a means of payment for purchases.
where: V is defined to be the velocity of money ~ the
average number of times a dollar is used to purchase a final
product or service during the year. [= (GNP) / (M) ]
where: P is the (general) price level
where: Q is the quantity of goods and services produced
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4. Banks lend $5 with which Borrowers
will buy a basket of goods and services
$5
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5. At a later time ~ Borrowers repay the $5 which
no longer buys the same basket of goods and
services.
$500
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6. This is why ~ Lenders hate inflation!
Borrow
w/IOU =
$5
now a Comparable
basket = $500 6
7. How does “Soft Money” affect prices?
• the supply of silver or greenbacks is greater
than the supply of gold
• the greater the money supply the less the
price or value of each dollar
• if the supply of money increases then prices
go up and each dollar buys less
• with inflation ~ lenders are nominally
repaid in less valuable dollars. They lose.
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8. Winners & Losers
Lenders lose purchasing Borrowers gain
power because the purchasing power
dollars they are repaid (at because the dollars
some later point in time) they repay (at some
are less powerful (of later point in time) are
lower value) than less powerful (of
lower value) than the
the dollars they originally dollars they originally
loaned borrowed
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9. The Money Supply
• “M1” is includes coins, currency,
demand deposits and other negotiable
accounts in the hands of the NON-
BANK public.
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10. the “FED” actions
to recall and summarize ~
•To stimulate the economy the FED engages in
actions to increase the money supply
•To contract the economy the FED engages in
actions to decrease the money supply
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11. Three Tools of Monetary Policy
• the Discount Rate is an interest rate a central bank
charges depository institutions borrowing reserves. For example
the Federal Reserve's discount window
• the Reserve Requirement (or cash reserve ratio) is
a central bank regulation setting the minimum fraction of
customer deposits and notes each commercial bank must hold as
reserves. These required reserves are in the form of cash stored
physically in a bank vault or deposits made with a central bank
• Open Market Operations is an activity by a central
bank to buy or sell government bonds on the open market. A
central bank uses the government bonds as the primary means of
implementing monetary policy
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12. How the FED influences the Money Supply
• to Increase the Money • to Decrease the Money
Supply Supply
– the FED can lower the – the FED can raise the
discount rate discount rate
– the FED can lower the – the FED can raise the
reserve requirement reserve requirement
– the FED can buy bonds – the FED can sell bonds
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13. Jefferson versus Hamilton
• Jefferson’s political philosophy
• Hamilton’s political philosophy
• Why would Jefferson be against
a central bank?
• Why would Hamilton be for
a central bank?
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15. 1896
Bryan versus
McKinley
William J. Bryan William
• The Cross of Gold McKinley
• Greenbacks or Silver
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16. Hard Money versus Soft Money
• Hard Money • Soft Money
– based upon gold – based upon silver or
greenbacks
– prevents inflation – causes inflation
– benefits lenders – benefits borrowers
– do the Republicans – do the Democrats favor
favor Hard Money…? Soft Money...?
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17. The Logic
• Soft Money (based upon greenbacks or
silver) causes inflation
• Hard money (gold) causes price stability
or deflation
• Borrowers (e.g. farmers and workers)
like Soft Money
• Lenders (e.g. bankers) like Hard Money
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18. Who is Helped and Hurt by
Unanticipated Inflation
• The eastern bankers ~ lenders
• Western farmers ~ borrowers
• Industrial workers ~ borrowers
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19. what are the
Measurements of Inflation
• the Consumer Price (the “CPI”) measures
changes in the price level of consumer goods and
services purchased by households
• the Producer Price Index (the “PPI”)
measures average changes in prices received by
domestic producers for their output
• the Implicit Price Deflator is an indicator
of the average increase in prices for all domestic
personal consumption
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20. Main Points
• The price level is determined by the relationship
between the amount of goods and services in the
economy and the amount of money
• Unanticipated inflation helps debtors and hurts
creditors
• The FED influences the money supply through the
discount rate, the reserve requirement and open
market operations
• Changes in the money supply influence aggregate
demand.
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