Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy
I.
The Impact of Monetary Policy on Output and Inflation
A.
Monetarists - A group of economists who believe that (1) monetary instability is the major cause of fluctuations in real GDP and (2) rapid growth of the money supply is the major cause of inflation.
B.
The Demand and Supply of Money
1.
Demand For Money - A curve that indicates the relationship between the interest rate and the quantity of money people want to hold. Because higher interest rates increase the opportunity cost of holding money, the quantity of money demanded will be inversely related to the interest rate.
2.
C.
The Equilibrium between Money Demand and Money Supply
1.
D.
How Does Monetary Policy Affect the Economy?
1.
Expansionary Monetary Policy - A shift in monetary policy designed to stimulate aggregate demand.
Injection of additional bank reserves, lower short-term interest rates, and an acceleration in the growth rate of the money supply are indicators of a more expansionary monetary policy.

Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy
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3.
The lower real interest rate will make current investment and consumption cheaper
4.
The lower interest rate will tend to cause financial capital to move abroad, the foreign exchange rate of the dollar to depreciate, and net exports to expand.
5.
The lower interest rate will tend to increase asset prices--for example, the prices of stocks, houses, and other structures people own--which will also increase aggregate demand.
E.
The Effects of an Unanticipated Expansionary Monetary Policy
1.
Thus, an unexpected increase in the supply of money will reduce the real rate of interest, thereby triggering an increase in the demand for goods and services. In turn, the increase in aggregate demand will expand real output and employment in the short run.
2.
F.
The Effects of an Unanticipated Restrictive Monetary Policy
1.
Restrictive Monetary Policy - A shift in monetary policy designed to reduce aggregate demand and put downward pressure on the general level of prices (or the rate of inflation). A reduction in bank

Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy reserves, higher short-term interest rates, and a reduction in the growth rate of the money supply are indicators of a more restrictive monetary policy.
2.
C.
G.
Shifts in Monetary Policy and Economic Stability
II.
Monetary Policy in the Long Run
A.
The Quantity Theory of Money
1.
Quantity theory of Money - A theory that hypothesizes that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money.
2.
The quantity theory of money predicts than an increase in the supply of money will cause a proportional increase in the price level.
3.
PY=GDP=MV
4.
Velocity of Money - The average number of times a dollar is used to purchase final goods and services during a year. It is equal to GDP divided by the stock of money.
5.
Rate of Inflation + Growth rate of real output = Growth rate of the money supply + Growth rate of velocity
6.
Equation of Exchange - MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the output of goods and services produced in an economy.
B.
Long-Run Impact of Monetary Policy: The Modern View

Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy
1.
B.
C.
Money and Inflation

Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy
1.
2.
When looked at over a lengthy time period, the link between money growth and inflation is one of the most consistent relationships in all of economics. Inflation is a monetary phenomenon. Persistently low rates of money growth lead to low rates of inflation. Similarly, high rates of money growth lead to high rates of inflation.
III.
Time Lags, Monetary shifts, and Economic Stability
A.
Measurement of Monetary Policy
B.
What Is the Taylor Rule and Why is it Important?
1.
Taylor Rule- A rule that indicates the federal funds interest rate that is most consistent with maximum sustainable output and price stability. Because the federal funds interest rate is largely determined by monetary policy, this rule acts as both a guide for monetary policy makers and a benchmark to evaluate their performance.
2.

Economics: Private & Public Choice | Part 3: Core Macroeconomics | Chapter 14: Modern Macroeconomics and
Monetary Policy
C.
C.
Did Monetary Policy Cause the Crisis of 2008?
1.
D.
Current Fed Policy and the Future