Professor Yamin Ahmad, Money and Banking – ECON 354
ECON 354
Money and Banking
Professor Yamin Ahmad
Professor Yamin Ahmad, Money and Banking – ECON 354
Main Concepts
Part I:
• What is Money;
y; Classifications of Money;
y; Functions of
Money
• The Quantity Theory of Money
– Velocity
– The Quantity Equation as a Demand for Money
– The Relationship
p between Inflation and Money
y Growth
Lecture 2:
• What is money?
• Review of AD/AS
and the effects of
monetary
t
policy
li
Part II:
• The Quantity Equation as Aggregate Demand
• Short and Long Run Effects of Monetary Policy Actions
• Stabilization Policy
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Part I:
U.S. inflation and its trend, 1960
1960-2006
2006
15%
Money...
y
% change in CPI from
12 months
th earlier
li
12%
long-run trend
9%
“If
If money were to grow on trees
trees, everybody would be dealing in
bananas.”
(- M. A.)
6%
3%
0%
1960 1965
Note: These lecture notes are incomplete without having attended lectures.
1970 1975
1980 1985
Note: These lecture notes are incomplete without having attended lectures.
1990 1995
2000 2005
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
What is Money: Definitions
The connection between money and prices
• Inflation rate = the percentage increase
in the average level of prices.
1.
• Price = amount of money required to
buy
y a good.
g
• Because
ecause p
prices
ces a
are
e de
defined
ed in te
terms
so
of money,
o ey,
we need to consider the nature of money,
the supply of money, and how it is controlled.
Note: These lecture notes are incomplete without having attended lectures.
Money is the stock
of assets that can be
readilyy used to make
transactions.
2. Money is anything that
is generally accepted in
payment for goods and
services
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
What is Money…(cont.)
Classifications of Money
• In the United States:
It is important to distinguish between money,
wealth and income:
 M1 = Currency + Traveler's Checks + Demand Deposits +
Other Checkable Deposits
• Money
– Stock
• Wealth: Money + Assets
– Stock
• Income: earnings at a point in time
Flow
Stock
 M2 = M1 + Small denomination time deposits & repurchase
agreements + Savings Deposits and money market deposit
accounts + Money Market mutual fund shares
(noninstitutional)
 M3 = M2 + Large denomination time deposits and
repurchase
p
agreements
g
+ Money
y Market mutual fund shares
(institutional) + Repurchase Agreements + Eurodollars
[Note: As of March 2006, the Fed has discontinued M3]
– Flow
• See: http://www.federalreserve.gov/releases/h6/hist/
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Money: Functions
Money supply measures, April 2009
symbol assets included
C
amount
($ billions)
Currency
$850
M1
C + demand deposits,
travelers’ checks,
other checkable deposits
$1592
M2
M1 + small time deposits,
p
savings deposits,
money market mutual funds,
money market deposit accounts
$8264
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Professor Yamin Ahmad, Money and Banking – ECON 354
• Medium of Exchange
g
we use it to buy stuff
• Store of Value
t
transfers
f
purchasing
h i power from
f
the
th presentt to
t the
th future
f t
• Unit of Account
the common unit by which everyone measures prices
and values
 Money helps to:
– Lower transaction costs
– Increase Liquidity in an economy
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Professor Yamin Ahmad, Money and Banking – ECON 354
Money as a Medium of Exchange
• Defn: A medium of exchange is any object that
is accepted in exchange for goods and services
• Examples of medium’s
medium s of exchange:
 Barter
 Cigarettes (WWII POW Camp)
 Credit Card
Money as a Unit of Account
• No unit of account:
• Question:
 What is the opportunity
cost of a movie in terms of
gum?
• Answer:
A

• B
Barter
t – goods
d and
d services
i
exchanged
h
d di
directly
tl
for other goods and services
– “Double
Double Coincidence of Wants”
Wants
Note: These lecture notes are incomplete without having attended lectures.
• Money as a unit of
account
Good
Price
P
i iin units
it off
another good
Movie
2 six-packs of soda
Soda
2 ice-cream cones
Ice Cream
3 packs of jelly
beans
Jelly Beans
2 sticks of gum
Gum
Note: These lecture notes are incomplete without having attended lectures.
1 local phone call
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Money: Types
1. Fiat Money
– has no intrinsic value
– example:
p
the p
paper
p currency
y we use
2. Commodity Money
– has intrinsic value
– examples:
gold coins,
cigarettes in P.O.W.
P O W camps (also in film: The
Shawshank Redemption starring Tim Robbins and
Morgan Freeman)
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Evolution of Payments System
• Precious metals like g
gold and silver ((commodityy money)
y)
• Paper currency (fiat money)
• Checks
• Electronic means of payment
• Electronic money: Debit cards, Stored-value cards,
Smart cards, E-cash
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Professor Yamin Ahmad, Money and Banking – ECON 354
What can serve as money?
Commodities must satisfy the following properties to serve
as money:
y
Discussion Question
Which of these are money?
a.
Currency
b
b.
Checks
• Standardized
c.
Deposits in checking accounts
((“demand deposits”)
p
)
• Divisible
d.
Credit cards
e.
Certificates of deposit
(“time deposits”)
• Widely accepted
• Easy to carry
• Not deteriorate easily
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Answers:
Professor Yamin Ahmad, Money and Banking – ECON 354
Best Definition of Money…?
Professor Yamin Ahmad, Money and Banking – ECON 354
Reliability of Money Data
What happened
to money in:
Problems arise because:
• 1968 – 71
• Post 1989
• Lack of frequency in
reporting deposits
 Different
stories about
what
h
happened
d tto
money
• Seasonal variations
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The money supply and
monetary policy definitions
• The money supply is the quantity of money
available in the economy.
y
• Monetary policy is the control over the money
supp y
supply.
 Focus on long run
monetary movements!
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The central bank
• Monetaryy policy
p y is conducted by
y a country’s
y
central bank.
• In the U.S.,
US
the central bank
is called the
Federal Reserve
(“the Fed”).
The Federal Reserve Building
Washington, DC
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
The Quantity Theory of Money
• A simple theory linking the inflation rate
to the growth rate of the money supply.
Velocity
• Basic Concept: the rate at which money circulates
• Definition: the number of times the average dollar
bill changes
h
h
hands
d iin a given
i
titime period
i d
• Begins with the concept of velocity…
• example: In 2007,
–
–
–
–
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
$500 billion in transactions
money supply = $100 billion
The average dollar is used in five transactions in 2007
So velocity = 5
So,
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Velocity cont.
Velocity,
cont
• This suggests the following definition:
V
T
M
where
V = velocity
T = value of all transactions
M = money supply
Velocity cont.
Velocity,
cont
• Use nominal GDP as a proxy for total
transactions.
Then,
V
P Y
M
where
P
= price
i off output
t t
Y
= quantity of output
P Y = value of output
(GDP deflator)
d fl t )
(real GDP)
(nominal GDP)
• Question: What is the difference between nominal GDP
and total transactions?
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Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Th quantity
The
tit equation
ti
• The quantity equation
M V = P Y
follows from the preceding definition of velocity.
• It is an identity:
it holds byy definition of the variables.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Money demand and the quantity
equation
• M/P = real money balances, the purchasing
power of the money supply.
• A simple money demand function:
(M/P)d = kY
where
k = how much money people wish to hold for
each dollar of income
income.
(k is exogenous)
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Money demand and the quantity
equation
• Money demand:
(M/P)d = kY
• Quantity equation:
M V = P Y
• The connection between them: k = 1/V
Back to the quantity theory of money
• starts with quantity equation
• assumes V is constant & exogenous: V V
• With this assumption, the quantity equation can
be written as
M V  P Y
• When people hold lots of money relative
to their incomes (k is high),
money changes hands infrequently (V is low)
low).
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The quantity theory of money, cont.
M V  P Y
Professor Yamin Ahmad, Money and Banking – ECON 354
A Quick Digression:
g
Two arithmetic tricks for
working with percentage changes
1. For anyy variables X and Y,,
How the price level is determined:
– With V constant, the money supply determines
percentage change in (X  Y )
 percentage change in X
+ percentage change in Y
nominal GDP (P Y ).
– Real GDP is determined by the economy’s supplies
of K and L and the production function.
– The price level is
P = (nominal
(
i l GDP)/(
GDP)/(reall GDP),
GDP) i.e.
i PY/Y
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Two arithmetic tricks for
working with percentage changes
2 percentage change in (X/Y )
2.
 percentage change in X
 percentage change in Y
EX:
If your hourly wage rises 5%
and you work 7% more hours
hours,
then your wage income rises
approximately 12%
12%.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The quantity theory of money, cont.
• So, from the preceding slides:
The growth rate of a product equals
the sum of the growth rates.
• The q
quantity
antit eq
equation
ation in gro
growth
th rates
rates:
M
EX: GDP deflator = 100  NGDP/RGDP.
If NGDP rises 9% and RGDP rises 4%
4%,
then the inflation rate is approximately 5%.
Note: These lecture notes are incomplete without having attended lectures.
M

V
V

P
P

Y
Y
The quantity theory of money assumes
V is constant,, so
Note: These lecture notes are incomplete without having attended lectures.
V
V
= 0.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
The quantity theory of money, cont.
 (Greek letter “pi”)
pi )
 
denotes the inflation rate:
M
The result from the
preceding slide was:
M
Solve this result
f  to
for
t gett
P
 

 
M
P
P
P
M
M


Y
Y
M

Y
Y
• N
Normall economic
i growth
th requires
i
a certain
t i
amount of money supply growth to facilitate the
growth in transactions
transactions.
Y
Y
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
• Money growth in excess of this amount leads
to inflation.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The quantity theory of money, cont.
 
The quantity theory of money, cont.
M
M

Y
Y
Y/Y depends on growth in the factors of
production and on technological progress
(all of which we take as given
given, for now).
Hence, the Quantity Theory predicts
a one-for-one
f
relation
l ti between
b t
changes in the money growth rate and
changes
h
in
i the
th inflation
i fl ti rate.
t
Note: These lecture notes are incomplete without having attended lectures.
Confronting the quantity theory with
data
The quantity theory of money implies
1. countries with higher money growth rates
should have higher inflation rates.
2. the long-run trend behavior of a country’s inflation
should be similar to the long-run trend in the country’s
money growth rate.
Are the data consistent with these implications?
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
International data on inflation and money growth
100
Turkey
Inflation rate
Ecuador
I d
Indonesia
i
(percent,
logarithmic scale)
U.S. inflation and money growth, 1960
1960-2006
2006
15%
Over the long run, the inflation and
money growth
th rates
t move together,
t
th
M2 growth
as the quantity
theory rate
predicts.
Belarus
12%
10
9%
Argentina
US
U.S.
1
Singapore
Switzerland
6%
3%
0.1
1
10
100
Money Supply Growth
(percent, logarithmic scale)
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Summary of Part I:
inflation
rate
0%
1960 1965
1970 1975
1980 1985
1990 1995
2000 2005
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Part II:
1. Money
– the stock of assets used for transactions
– serves as a medium of exchange, store of value, and unit of
account
account.
– Commodity money has intrinsic value, fiat money does not.
– Central bank controls the money supply.
2. Quantity theory of money assumes velocity is stable
2
stable,
concludes that the money growth rate determines the
inflation rate.
Note: These lecture notes are incomplete without having attended lectures.
Review of AD/AS and the Effects of
Monetary Policy
What happens when the Fed changes
the quantity of money circulating in the
economy?
?
Professor Yamin Ahmad, Money and Banking – ECON 354
Time horizons in macroeconomics
Professor Yamin Ahmad, Money and Banking – ECON 354
Classical Macro Theory
• Output is determined by the supply side:
• Long run
Prices are flexible, respond to changes in supply or
demand.
• Short run
Many prices are “sticky”
sticky at some predetermined level
level.
– supplies
s pplies of capital
capital, labor
– technology.
• Changes in demand for goods & services
(C, I, G ) only affect prices, not quantities.
• Assumes complete price flexibility.
The economy behaves much
diff
differently
tl when
h prices
i
are sticky.
ti k
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
When prices are sticky…
sticky
…output and employment also depend on
demand, which is affected by
– fiscal policy (G and T )
– monetary policy (M )
– other factors, like exogenous changes in
C or I.
• Applies to the long run.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
The Model off Aggregate Demand and Supply
S
• the p
paradigm
g most mainstream economists
and policymakers use to think about economic fluctuations
and policies to stabilize the economy
• shows how the price level and aggregate output are
determined
• shows how the economy’s behavior is different
in the short run and long run
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Aggregate Demand
The Quantity Equation as
Aggregate Demand
• The aggregate demand curve shows the relationship
between the price level and the quantity of output
demanded.
• Consider the following
g equation
q
of exchange:
g The
Quantity Equation
MV = PY
• For this lecture’s intro to the AD/AS model,
we use a simple theory of aggregate demand based
on the quantity theory of money.
• For given values of M and V,
this equation implies an inverse relationship between P
and Y
• In general, the AD curve will be derived from the IS/LM
Model
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
The downward
downward-sloping
sloping AD curve
Shifti th
Shifting
the AD curve
P
P
An increase in the price
level causes a fall in
real money balances
(M/P),
An increase in the
money supply shifts
the AD curve to the
right.
causing a decrease in
th d
the
demand
d ffor goods
d
& services.
AD2
AD
AD1
Y
Note: These lecture notes are incomplete without having attended lectures.
Y
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Aggregate Supply in the long run
Q
Question:
ti
Why
Wh did the
th AD shift?
hift?
•
• Consider the following:
– For a given price level (i.e. holding the price level
fixed), if M increased, what would happen to
demand? i.e. would it increase or decrease as a
result?
Y  F (K , L )
Y
• Question:
– Suppose now that something caused velocity
velocity, V
V, to
increase. What happens to the demand curve?
Note: These lecture notes are incomplete without having attended lectures.
“Full employment” means that
unemployment equals its natural rate (not zero).
Professor Yamin Ahmad, Money and Banking – ECON 354
The long-run
long run aggregate supply curve
P
is the full-employment or natural level of output, the
p at which the economy’s
y resources are
level of output
fully employed.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Y does not
In the long run, output is determined by factor supplies and
technology
Long-run
Long
run effects of an increase in M
P
LRAS
LRAS
An iincrease iin
A
M shifts AD to
the right.
depend on P,
so LRAS is
vertical.
In the long run, this
raises the price
level…
P2
P1
AD2
AD1
Y
 F (K , L )
Note: These lecture notes are incomplete without having attended lectures.
Y
…but leaves output
the same.
Note: These lecture notes are incomplete without having attended lectures.
Y
Y
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Aggregate Supply in the short run
Th short-run
The
h t
aggregate
t supply
l curve
• Many prices are sticky in the short run.
The SRAS curve is
horizontal:
The price level is
fixed
ed a
at a
predetermined level,
and firms sell as
much as buyers
demand.
• For now we will assume
– all prices are stuck at a predetermined level in the short run
run.
– firms are willing to sell as much at that price level as their
customers are willing to buy.
P
SRAS
P
• Therefore, the short-run aggregate supply (SRAS) curve
is horizontal:
Y
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Short run effects of an increase in M
Short-run
In the short run
when prices are
sticky,…
P
Over time, prices gradually become “unstuck.” When they do,
will they rise or fall?
…an
an increase in
aggregate
demand…
…causes output to
rise
rise.
Note: These lecture notes are incomplete without having attended lectures.
In the short-run
equilibrium, if
SRAS
AD2
AD1
P
Y1
Y2
From the short run to the long run
Y
then over time,
P will…
Y Y
rise
Y Y
fall
Y Y
remain
i constant
t t
The adjustment of prices is what moves the economy to its
l
long-run
equilibrium.
ilib i
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Shock!!!
The SR & LR effects of M > 0
A = initial
equilibrium
B = new short-run
h t
eq’m after Fed
increases M
P
• Shocks: exogenous changes in agg. supply or demand
LRAS
• Shocks temporarily push the economy away from full
employment.
C
P2
B
P
A
C = long-run
equilibrium
SRAS
AD2
AD1
Y
Y2
Y
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Supply shocks
The Effects of a Negative Demand Shock
Over time, prices
fall and the
economy moves
down its demand
curve toward fullfull
employment.
P
P
If the money supply is held constant, a decrease in V
means p
people
p will be using
g their money
y in fewer
transactions, causing a decrease in demand for goods
and services.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
AD shifts left,
depressing output and
employment
in the short run.
• Example: exogenous decrease in velocity
• A supply shock alters production costs, affects the
prices that firms charge. (also called price shocks)
LRAS
B
P2
A
SRAS
C
AD1
AD2
Y2
Note: These lecture notes are incomplete without having attended lectures.
Y
Y
• Examples of adverse supply shocks:
– Bad weather reduces crop yields,
yields pushing up
food prices.
– Workers unionize,, negotiate
g
wage
g increases.
– New environmental regulations require firms to
reduce emissions. Firms charge higher prices to help
cover the
th costs
t off compliance.
li
• Favorable supply shocks lower costs and prices
prices.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
CASE STUDY: The 1970s oil shocks
CASE STUDY: The 1970s oil shocks
The oil price shock
shifts
hift SRAS up,
causing output and
employment to fall.
• Early
y 1970s: OPEC coordinates a reduction in the
supply of oil.
• Oil prices rose
11% in 1973
68% in 1974
16% in 1975
In absence of
f th price
further
i shocks,
h k
prices will fall over
time and economy
moves back toward
full employment.
• Such sharp oil price increases are supply shocks
because they significantly impact production costs and
prices.
B
P2
SRAS2
A
P1
SRAS1
AD
Y
Y
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
CASE STUDY: The 1970s oil shocks
CASE STUDY: The 1970s oil shocks
70%
60%
12%
60%
50%
10%
40%
8%
30%
20%
6%
Late 1970s:
As economy
was recovering,
oil prices shot up
again, causing
another huge supply
shock!!!
14%
0%
50%
12%
40%
10%
30%
8%
20%
6%
10%
10%
0%
1973
LRAS
Y2
Note: These lecture notes are incomplete without having attended lectures.
Predicted effects
of the oil shock:
• inflation 
• output 
• unemployment 
…and then a gradual
recovery
recovery.
P
1974
1975
1976
4%
1977
0%
19
1977
4%
19 8
1978
19 9
1979
1980
Change in oil prices (left scale)
Change in oil prices (left scale)
Inflation rate-CPI ((right
g scale))
Inflation rate-CPI
rate CPI (right scale)
Unemployment rate (right scale)
Unemployment rate (right scale)
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
1981
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
CASE STUDY: The 1980s oil shocks
Stabilization policy
40%
1980s:
A favorable supply
shock-a significant fall in
oil prices.
As the model
predicts,
inflation and
unemployment fell:
10%
30%
8%
20%
• Def: p
policy
y actions aimed at reducing
g the severity
y of
short-run economic fluctuations.
10%
6%
0%
-10%
4%
-20%
30%
-30%
• Example: Using monetary policy to combat the effects of
adverse supply shocks:
2%
-40%
-50%
1982
0%
1983
1984
1985
1986
1987
Change in oil prices (left scale)
Inflation rate-CPI
rate CPI (right scale)
Unemployment rate (right scale)
Note: These lecture notes are incomplete without having attended lectures.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Professor Yamin Ahmad, Money and Banking – ECON 354
Stabilizing Output with Monetary Policy
P
The adverse
pp y shock
supply
moves the
economy to
point B.
P2
Stabilizing Output with Monetary Policy
LRAS
B
But the Fed
accommodates the
shock by raising
agg. demand.
SRAS2
A
P1
SRAS1
AD1
Y2
Note: These lecture notes are incomplete without having attended lectures.
Y
Y
P
P2
results:
P is permanently
g , but Y remains
higher,
at its full-employment
level.
LRAS
B
C
SRAS2
A
P1
AD1
Y2
Note: These lecture notes are incomplete without having attended lectures.
Y
AD2
Y
Professor Yamin Ahmad, Money and Banking – ECON 354
Summary of Part II
1. Long run: prices are flexible, output and employment are
always at their natural rates, and the classical theory
applies.
Short run: prices are sticky
sticky, shocks can push output and
employment away from their natural rates.
2. Aggregate demand and supply:
a framework to analyze economic fluctuations
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Summary of Part II
6. Shocks to aggregate demand and supply cause
fluctuations in GDP and employment in the short run.
7 The
7.
Th Fed
F d can attempt
tt
t to
t stabilize
t bili the
th economy with
ith
monetary policy.
Note: These lecture notes are incomplete without having attended lectures.
Professor Yamin Ahmad, Money and Banking – ECON 354
Summary of Part II
3. The aggregate demand curve slopes downward.
4 The long
4.
long-run
run aggregate supply curve is vertical
vertical, because
output depends on technology and factor supplies, but
not prices.
5 The short
5.
short-run
run aggregate supply curve is horizontal,
horizontal
because prices are sticky at predetermined levels.
Note: These lecture notes are incomplete without having attended lectures.