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Mpp#020+monetary.policy.(20)
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  • 1. Monetary Policythe expected effects of the FED’sutilization of Monetary Policy to facilitate the economy’s growth 1
  • 2. The Price Level is determined by:The relationship betweenthe amount of money incirculation and the amountof goods and services in theeconomy. Remember: MV = PQ 2
  • 3. the Equation of Exchange MV = PQwhere: M is defined to be the money supply ~ currency +demand deposits + travelers’ checks = money since these items areused as a means of payment for purchases.where: V is defined to be the velocity of money ~ theaverage number of times a dollar is used to purchase a finalproduct or service during the year. [= (GNP) / (M) ]where: P is the (general) price levelwhere: Q is the quantity of goods and services produced 3
  • 4. Banks lend $5 with which Borrowerswill buy a basket of goods and services $5 4
  • 5. At a later time ~ Borrowers repay the $5 whichno longer buys the same basket of goods andservices. $500 5
  • 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. 7
  • 8. Winners & Losers Lenders lose purchasing Borrowers gain power because the purchasing powerdollars 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 thethe dollars they originally dollars they originally loaned borrowed 8
  • 9. The Money Supply• “M1” is includes coins, currency, demand deposits and other negotiable accounts in the hands of the NON- BANK public. 9
  • 10. the “FED” actionsto recall and summarize ~•To stimulate the economy the FED engages inactions to increase the money supply•To contract the economy the FED engages inactions to decrease the money supply 10
  • 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 Reserves 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 11
  • 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 12
  • 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? 13
  • 14. Oz and the Election of 1896 14
  • 15. 1896 Bryan versus McKinleyWilliam J. Bryan William • The Cross of Gold McKinley • Greenbacks or Silver 15
  • 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...? 16
  • 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 17
  • 18. Who is Helped and Hurt by Unanticipated Inflation • The eastern bankers ~ lenders • Western farmers ~ borrowers • Industrial workers ~ borrowers 18
  • 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 19
  • 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. 20