Monetary Policy

Monetary Policy

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.

MV = PQ

$5

Banks lend $5 which will buy a basket of goods and services

Borrowers repay $5 which no longer buys the same basket of goods and services.

$500

$500

IOU $5

Lenders hate inflation!

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/value of each dollar.

• If the supply of money increases, prices go up, each dollar buys less.

• With inflation, lenders are repaid in less valuable dollars. They lose.

Winners and Losers

Lenders

lose purchasing power because dollars they are repaid are less powerful than those they loaned

Borrowers

gain purchasing power because dollars they repay are less powerful than those they borrowed

The Money Supply

• Coins, currency, demand deposits, and other negotiable accounts in the hands of the NON-BANK public.

FED actions

• To stimulate the economy, increase the

money supply

• To contract the economy, decrease the

money supply

Three tools of monetary policy

• Discount rate

• Reserve requirement

• Open market operations

How the FED influences the money supply

• Increase the money supply– Lower the discount

rate

– Lower the reserve requirement

– Buy bonds

• Decrease the money supply– Raise the discount rate

– Raise the reserve requirement

– Sell bonds

Jefferson and 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?

Oz and the Election of 1896

Bryan and McKinley

• The Cross of Gold

• Greenbacks or silver

Hard vs Soft Money

• Hard Money

– gold

– prevents inflation

– benefits lenders

– Republicans favor it

• Soft Money

– silver or greenbacks

– causes inflation

– benefits borrowers

– Democrats favor it

The Logic

• Soft Money (greenbacks or silver) causes inflation

• Hard money (gold) causes price stability or deflation

• Borrowers (farmers and workers)like soft money Lenders (bankers) like hard money

Helped and Hurt by Unanticipated Inflation

• The eastern bankers - lenders

• Western farmers - borrowers

• Industrial workers - borrowers

Measurements of Inflation

• Consumer Price Index

• Producer Price Index

• Implicit Price Deflator

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, reserve requirement, and open market operations.

• Changes in the money supply influence aggregate demand.