1. Monetary policy uses tools like interest rates, reserve requirements, and open market operations to influence the money supply and shift the aggregate demand curve to achieve goals like economic growth and stable prices. 2. Reserve requirements determine the minimum amount of deposits banks must hold in reserves rather than lend out, affecting how much money banks can create through fractional-reserve lending. 3. Interest rates and open market operations work together to control interbank rates, which then influence broader economic activity levels. Lower rates spur more lending and borrowing.

1. Abbreviated version of the
tools of monetary policy

2. Abbreviated version of the
tools of monetary policy
A condensed version

3. Monetary Policy
Monetary Policy
AD = C + I + G + (X – M)
- is the use of targeting inflation,
interest rates, and the exchange
rates to shift the AD curve.
Reworded definition: 换句话说
- is the use of changing the supply of
money to sustain economic growth
and smooth 连出 the business cycle.

4. AD = C + I + G + (X – M)
Types of Monetary Policy

5. - An increase in the money supply to
increase AD
Expansionary
Monetary Policy
Types of Monetary Policy
AD = C + I + G + (X – M)
Inflationary
Monetary Policy
or
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
Shifts AD right

6. Types of Monetary Policy
AD = C + I + G + (X – M)
Contractionary
Monetary Policy
Deflationary
Monetary Policy
or
Money Supply
***Ceteris Paribus
Definition with arrows: 换句话说
Shifts AD left
- An decrease in the money supply to
increase AD
Expansionary
Monetary Policy

7. Expansionary Fiscal Policy
AD = C + I + G + (X – M)
Money Supply
Price
level
GDP
AD
SRAS
PE
LRAS
YN Y1
P1
AD1
(PED > 1)

8. Time
Long Run
Short Run
Econ
Growth
- is the use of the federal budget to
sustain economic growth and smooth
the business cycle.
Fiscal Policy
Use Contractionary
Monetary Policy
Use
Expansionary
Monetary Policy

9. Time
Long Run
Short Run
Business Cycle
Econ
Growth
- is the use of the federal budget to
sustain economic growth and smooth
the business cycle.
Fiscal Policy

10. AD = C + I + G + (X – M)
Tools of Monetary Policy
(PED > 1)

11. AD = C + I + G + (X – M)
Tools of Monetary Policy
Reserve Requirements (rr)
Interest Rates (ir)
Open Market Operations (omo)
Exchange Rate Controls (Forex controls)
Quantitative Easing (QE)

12. AD = C + I + G + (X – M)
Tools of Monetary Policy
Reserve
Requirements
(rr)
- the minimum fraction of customer
deposits that each commercial bank
must hold as reserves
(rather than lend out).
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the (rr)

13. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- The main rate charged to
commercial banks from the central
bank
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the (ir) (discount/base rate)
Discount Rate
What it is called
in the US
Base Rate
What it is called
in the UK

14. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- The main rate charged to
commercial banks from the central
bank
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the (ir) (discount/base rate)
Discount Rate
What it is called
in the US
Base Rate
What it is called
in the UK
The main rates controlled by the
central bank of the country.

15. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- benchmark rate that some of the
world's leading banks charge each
other for short-term loans. (inter-bank)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the inter-bank rate
Federal funds rate
What it is called
in the US
Libor
What it is called
in the UK

16. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- benchmark rate that some of the
world's leading banks charge each
other for short-term loans. (inter-bank)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the inter-bank rate
Federal funds rate
What it is called
in the US
Libor
What it is called
in the UK
The rates between the large banks
of each country.

17. AD = C + I + G + (X – M)
Tools of Monetary Policy
Open Market
Operations
(omo)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
buying securities
- buying and selling government
securities in an attempt to control
interbank interest rates
- ( libor –UK)
- ( federal funds rate – US)

18. AD = C + I + G + (X – M)
Tools of Monetary Policy
Exchange
Rate controls
(FOREX
controls) Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
increase Depreciation
- Managing the use of the countries
money between countries

19. AD = C + I + G + (X – M)
Tools of Monetary Policy
Quantitative
Easing
(QE)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
buying securities
- Buying and selling more types of
securities
- used by central banks to stimulate the
economy when standard monetary
policy has become ineffective.

20. AD = C + I + G + (X – M)
A short explanation of how
each tool of Monetary
Policy work
(PED > 1)

21. AD = C + I + G + (X – M)
Tools of Monetary Policy
Reserve
Requirements
(rr)
- the minimum fraction of customer
deposits that each commercial bank
must hold as reserves
(rather than lend out).
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the (rr)

22. banks keep a fraction of deposits as reserves
and use the rest to make loans.
The central bank of a country establishes reserve
requirements,
regulations on the minimum amount of reserves
that banks must hold against deposits.
The reserve ratio, rr
= fraction of deposits that banks hold as reserves
= total reserves as a percentage of total deposits
How Banks Make Money
fractional
reserve
banking
system,
部分准备
金银行制度
Excess reserves are bank reserves over and
above its required reserves.

23. Bank T-account
T-account: a simplified accounting statement
that shows a bank’s assets & liabilities.
Example:
FIRST NATIONAL BANK
Assets Liabilities
Reserves $ 10
Loans $ 90
Deposits $100
 Banks’ liabilities include deposits,
assets include loans & reserves.
 In this example, notice that rr = $10/$100 = 10%.

24. An Example:
Suppose $100 of currency is in circulation.
To determine banks’ impact on money supply,
we calculate the money supply in 3 different
cases:
Case 1. No banking system
Case 2. 100% reserve banking system:
banks hold 100% of deposits as reserves,
make no loans
Case 3. Fractional reserve banking system
How Banks Make Money

25. CASE 1: No banking system
Public holds the $100 as currency.
Money supply = $100.
How Banks Make Money

26. CASE 2: 100% reserve banking system
Public deposits the $100 at First National Bank (FNB).
FIRST NATIONAL BANK
Assets Liabilities
Reserves $100
Loans $ 0
Deposits $100
FNB holds
100% of
deposit
as reserves:
Money supply = currency + deposits = $0 +
$100 = $100
How Banks Make Money
In a 100% reserve banking system,
banks do not affect size of money supply.

27. CASE 3: Fractional reserve banking system
Money supply = $190 (!!!)
Depositors have $100 in deposits,
Borrowers have $90 in currency.
1 - FIRST NATIONAL BANK
Assets Liabilities
Reserves $100
Loans $ 0
Deposits $100
Suppose rr = 10%.
1-NB loans all but 10% of the deposit:
10
90
How Banks Make Money

28. CASE 3: (Continued..) Fractional reserve banking system
If R = 10% for 2-NB, it will loan all but 10% of the
deposit.
2- SECOND NATIONAL BANK
Assets Liabilities
Reserves $ 90
Loans $ 0
Deposits $ 90
Suppose borrower deposits the $90 at Second National
Bank (2-NB).
Initially, 2-NB’s
T-account looks
like this:
9
81
How Banks Make Money

29. If R = 10% for 3-NB, it will loan all but 10% of the
deposit.
3- THIRD NATIONAL BANK
Assets Liabilities
Reserves $ 81
Loans $ 0
Deposits $ 81
The borrower deposits the $81 at Third National Bank
(TNB).
Initially, 3-NB’s
T-account looks
like this:
$ 8.10
$72.90
How Banks Make Money
CASE 3: (Continued..) Fractional reserve banking system

30. The process continues, and money is created with each new loan.
Original deposit =
1-NB lending =
2-NB lending =
3-NB lending =
...
$ 100.00
$ 90.00
$ 81.00
$ 72.90
...
Total money supply = $ 1000.00
In this
example,
$100 of
reserves
generates
$1000 of
money.
How Banks Make Money
CASE 3: (Continued..) Fractional reserve banking system

31. The Money Multiplier
The Credit multiplier = 1/rr.
In our example,
rr = 10%
money multiplier = 1/rr = 10
$100 of reserves creates
$1000 of money
Credit
multiplier
or
Money
multiplier
- the amount of money the
banking system generates
with each dollar of reserves.

32. AD = C + I + G + (X – M)
Tools of Monetary Policy
Reserve
Requirements
(rr)
(rr) increases AD by increasing the
amount of money that banks can
lend out which creates more loans
and hence more economic activity.

33. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- The main rate charged to
commercial banks from the central
bank
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the (ir) (discount rate)
Discount Rate
What it is called
in the US
Base Rate
What it is called
in the UK

34. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
- benchmark rate that some of the
world's leading banks charge each
other for short-term loans. (interbank)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
the interbank rate
Federal funds rate
What it is called
in the US
Libor
What it is called
in the UK

35. AD = C + I + G + (X – M)
Tools of Monetary Policy
Open Market
Operations
(omo)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
buying securities
- buying and selling government
securities in an attempt to control
interbank interest rates
- ( libor –UK)
- ( federal funds rate – US)

36. AD = C + I + G + (X – M)
Tools of Monetary Policy
Open Market
Operations
(omo)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
buying securities
- buying and selling government
securities in an attempt to control
interbank interest rates
- ( libor –UK)
- ( federal funds rate – US)
Combine Interest Rates
and OMO together into
a single explanation
because they are
serving the same
function.

37. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
This is about direct control of the
main interest rate in the country
that in turn controls the other
interest rates. The lower the rate
the higher the possible economic
activity.

38. AD = C + I + G + (X – M)
Tools of Monetary Policy
Open Market
Operations
(omo)
This is about buying and selling
securities between the banks of a
country that in turn control the
interest rate between banks and in
turn the whole economy. The lower
the rate the higher the possible
economic activity.

39. The Quantity Theory of Money
 Developed by 18th century philosopher
David Hume and the classical economists
 Advocated more recently by Nobel Prize Laureate
Milton Friedman
 Asserts that the quantity of money determines the
value of money
 We study this theory using two approaches:
1. A supply-demand diagram
2. An equation

40. 1.) The Money Supply-Demand Diagram
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1 1
¾ 1.33
½ 2
¼ 4
As the value of
money rises, the
price level falls.

41. 1.) The Money Supply-Demand Diagram
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1 1
¾ 1.33
½ 2
¼ 4
As the value of
money rises, the
price level falls.Price of money =
interest rate =
depends on the
value of money

42. - is the relationship between the
quantity of money supplied and
the nominal interest rate.
The Quantity Theory of Money
1.) A supply-demand diagram
The Supply of
Money
(MS)
- It is controlled by banks and is
fixed at any given point in time
so it is a perfectly inelastic line.
Supply is fixed by
the central bank

43. Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1
¾
½
¼
1
1.33
2
4
MS1
$1000
Central Banks set MS
at some fixed value,
regardless of P.
1.) The Money Supply-Demand Diagram

44. Money Demand
(MD)
-is the relationship between the
quantity of money demanded and
the nominal interest rate.
The Quantity Theory of Money
1.) A supply-demand diagram
Demand is set by how
much people want in
liquid form.

45. Money Demand
(MD)
-is the relationship between the
quantity of money demanded and
the nominal interest rate.
The Quantity Theory of Money
1.) A supply-demand diagram
Depends on P:
An increase in P reduces
the value of money,
so more money is required
to buy g&s.

46. Money Demand
(MD)
1.) The Transactions motive:
To pay for stuff
2.) The Precautionary motive:
Just in case bad S#!% happens
3.) The Speculative motive:
To speculate on investments such as
bonds.
The Quantity Theory of Money
1.) A supply-demand diagram
Liquidity theory

47. 1.) The Money Supply-Demand Diagram
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1
¾
½
¼
1
1.33
2
4
MD1
A fall in value of money (or
increase in P) increases the
quantity of money demanded:

48. Supply is fixed by
the central bank
The value of money is determined by the supply and demand for money
1.) The Money Supply-Demand Diagram
Demand is set by how
much people want in
liquid form
In the long run,
the overall price level adjusts to the level at
which the demand for money equals the
supply of money.

49. MS1
$1000
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1
¾
½
¼
1
1.33
2
4
MD1
P adjusts to equate
quantity of money
demanded with money
supply.
EQ
price
level
EQ
value
of
money
A
1.) The Money Supply-Demand Diagram

50. MS1
$1000
Value of
Money, 1/P
Price
Level, P
Quantity
of Money
1
¾
½
¼
1
1.33
2
4
MD1
EQ
price
level
EQ
value
of
money
A
MS2
$2000
B
Then the value of
money falls,
and P rises.
Suppose the central
bank increases the
money supply.
1.) The Money Supply-Demand Diagram

51. AD = C + I + G + (X – M)
Tools of Monetary Policy
Open Market
Operations
(omo)
Buying and selling securities
between the banks of a country
changes the money supply which
changes the interest rates through
the market mechanism.

52. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
The central bank controls it’s own
interest rate to the other banks
which indirectly controls the other
rates. If it decreases it’s own
interest rate then this can increase
the money supply.

53. The Quantity Theory of Money
 Developed by 18th century philosopher
David Hume and the classical economists
 Advocated more recently by Nobel Prize Laureate
Milton Friedman
 Asserts that the quantity of money determines the
value of money
 We study this theory using two approaches:
1. A supply-demand diagram
2. An equation
We will use this to explain why in the
long run this type of policy can be
ineffective.

54. AD = C + I + G + (X – M)
Tools of Monetary Policy
Exchange
Rate controls
(FOREX
controls) Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
increase Depreciation
- Managing the use of the countries
money between countries
This is mostly about
increasing X and
decreasing M in the (x-
m) part.

55. AD = C + I + G + (X – M)
Tools of Monetary Policy
Exchange
Rate controls
(FOREX
controls) Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
increase Depreciation
- Managing the use of the countries
money between countries
I assume you remember,
so just a few reminder
issues...

56. the rate at which one country’s
currency trades for another.
Nominal exchange
rate:
( Nominal variables )
FOREX Vocab

57. FOREX Vocab
Equation =
e x P
P*
( Real variables )
Real exchange
rate:
the rate at which the good and service
of one country trade for the goods and
services of another.
P = domestic price
P* = foreign price (in foreign currency)
e = nominal exchange rate, i.e., foreign
currency per unit of domestic currency

58. A fall in the value of a currency
compared to other currencies.
It now buys less then before.
ex. - £1 = € 1.50 £1 = € 1.45
the balance of payments should
‘improve’
Depreciation
Appreciation A rise in the value of a currency
compared to other currencies.
It now buys more then before.
ex. - £1 = $1.85 £1 = $1.91
the balance of payments should get
‘worse’
FOREX Vocab
This will
depend on
elasticity of
imports and
exports
(Weak)
(Strong)

59. Summary
Nominal – what is the amount of money do I
need to exchange today?
Real – how many things can I buy with the
exchange?
LoOP – Ceteris Paribus, Goods should sells for
the same price in all markets ( Real = Nominal)
PPP – Ceteris Paribus, Prices should buy the same
number of goods (Nominal = Real)

60. Balance of Payments
Is it a problem not to have a
balanced trade?

61. Balance of Payments
Current account
Income
Current Transfers
Trade in Goods
Trade in Services
If (NET ) total is negative =
Trade Deficit
If (NET ) total is positive =
Trade Surplus
Capital account
Financial account
Financial account
Financial assets
Off-sets
Non – Financial assets
Fixed assets
Capital account
Official Reserves
If (NET ) total is negative =
Trade Surplus
If (NET ) total is positive =
Trade Deficit

62. Balance of Payments
Current account
Income
Current Transfers
Trade in Goods
Trade in Services
If (NET ) total is negative =
Trade Deficit
If (NET ) total is positive =
Trade Surplus
Capital account
Financial account
Financial account
Financial assets
Off-sets
Non – Financial assets
Fixed assets
Capital account
Official Reserves
If (NET ) total is negative =
Trade Surplus
If (NET ) total is positive =
Trade Deficit
All these, especially the
current account would have
to be discussed to use
exchange rates to solve these
problems.

64. Test tip: Talk about the j-
curve every possible time!

65. AD = C + I + G + (X – M)
Tools of Monetary Policy
Quantitative
Easing
(QE)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
buying securities
- Buying and selling more types of
securities
- used by central banks to stimulate the
economy when standard monetary
policy has become ineffective.

66. AD = C + I + G + (X – M)
Tools of Monetary Policy
Quantitative
Easing
(QE)
Briefly, it is just like (OMO) except
now they are buying and selling
even more types of assets, not
just bonds and things but other
financial instruments.

68. Basically anything they think
would work.

69. The first time this ever happened was in 2008.
The central bank bought Mortgage-backed
securities. Basically they bought bad overpriced
home loans so the regular banks weren’t stuck
with these assets that they were losing money
on.

70. AD = C + I + G + (X – M)
Limitations of Monetary
Policy

71. Pushing on a string

72. Just because you have more money
supplied doesn’t always mean your
automatically going to have more
spending. If consumer confidence is low,
this may not help people feel better.

73. AD = C + I + G + (X – M)
Limitations of Monetary Policy
Liquidity trap
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply
Not shift AD
A situation in which interest rates are low
and savings rates are high, making
monetary policy ineffective

74. Milton Friedman (1912 – 2006) was an American economist,
statistician统计学家, and writer who taught at the University of Chicago. He
won the Nobel Prize in Economics诺贝尔经济学奖, and is known for his
research on consumption analysis消费函数, monetary history and theory 货币理
论, and the complexity of stabilization policy.

75. Milton Friedman (1912 – 2006) was an American economist,
statistician统计学家, and writer who taught at the University of Chicago. He
won the Nobel Prize in Economics诺贝尔经济学奖, and is known for his
research on consumption analysis消费函数, monetary history and theory 货币理
论, and the complexity of stabilization policy.
He said money is really really really
important, monetary policy is more
powerful then fiscal policy

76. Milton Friedman (1912 – 2006) was an American economist,
statistician统计学家, and writer who taught at the University of Chicago. He
won the Nobel Prize in Economics诺贝尔经济学奖, and is known for his
research on consumption analysis消费函数, monetary history and theory 货币理
论, and the complexity of stabilization policy.
The discretionary part of fiscal policy is
often poor because the government has
poor information or is very insufficient.

77. Milton Friedman (1912 – 2006) was an American economist,
statistician统计学家, and writer who taught at the University of Chicago. He
won the Nobel Prize in Economics诺贝尔经济学奖, and is known for his
research on consumption analysis消费函数, monetary history and theory 货币理
论, and the complexity of stabilization policy.
Also he says that the discretionary part of
monetary policy can be even more
dangerous so the policy should be stable
inflation and very little government
“meddling” with the tools.

78. The Quantity Theory of Money
 Developed by 18th century philosopher
David Hume and the classical economists
 Advocated more recently by Nobel Prize Laureate
Milton Friedman
 Asserts that the quantity of money determines the
value of money
 We study this theory using two approaches:
1. A supply-demand diagram
2. An equation

79. The Quantity Theory of Money
 Developed by 18th century philosopher
David Hume and the classical economists
 Advocated more recently by Nobel Prize Laureate
Milton Friedman
 Asserts that the quantity of money determines the
value of money
 We study this theory using two approaches:
1. A supply-demand diagram
2. An equation
It’s just going to create inflation in the
long run.

80. Quantity Theory of
Money
The value of money is determined
by the supply and demand for
money
In the long run, the overall
price level adjusts to the level
at which the demand for
money equals the supply of
money.
(nominal changes don’t affect
real changes)
Classical Theory
Neutrality of Money

81. Q Theory of Money
Another theory to go with these to
explain this position on money.
Classical Theory
N of Money
The Velocity of Money
The V of Money
the rate at which money
changes hands.
v =
P x Y
M
Equation:

82. Classical Theory
The Velocity of Money
The V of Money
the rate at which money
changes hands.
v =
P x Y
M
Equation:
P x Y = (price level) x (real GDP)
M = money supply
V = velocity

83. The Velocity of Money Example:
Example with one good:比萨.
Y = real GDP = 5000比萨
P = price level = price of比萨 = 100元
P x Y = value of 比萨 = 500,000元
M = money supply = 100,000元
V = velocity = 500,000/100,000 = 5
The average yuan was used in 5 transactions.
Velocity formula: v =
P x Y
M

84. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
In the long run the policies can
become ineffective like “pushing on
a string”

85. AD = C + I + G + (X – M)
Tools of Monetary Policy
Interest Rates
(ir)
Milton Friedman basically wants good
old fashioned supply and demand and
the market mechanism to do the job it’s
known to do well, and not have the
government “steer” it, since they can
steer it right but also very wrong.

86. It’s is for now.
Thank you 