10 MONEY AND PRICES IN THE LONG RUN Chapter 29 The Monetary System

10 MONEY AND PRICES IN THE LONG

RUN

Chapter 29The Monetary System

29.1 The Meaning of Money

• Money is the set of assets in an economy that people regularly use to buy goods and services from other people.

29.1.1 The Functions of Money

• Money has three functions in the economy:

– Medium of exchange

– Unit of account

– Store of value


• Medium of Exchange

– A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services.

– A medium of exchange is anything that is readily acceptable as payment.


• Unit of Account

– A unit of account is the yardstick people use to post prices and record debts.

• Store of Value

– A store of value is an item that people can use to transfer purchasing power from the present to the future.


• Liquidity

– Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange.

29.1.2 The Kinds of Money

• Commodity money takes the form of a commodity with intrinsic value.

– Examples: Gold, silver, cigarettes.

• Fiat money is used as money because of government decree.

– It does not have intrinsic value.

– Examples: Coins, currency, check deposits.

29.1.3 Money in the U.S. Economy

• Currency is the paper bills and coins in the hands of the public.

• Demand deposits 活期存款 are balances in bank accounts that depositors can access on demand by writing a check.

Figure 1 Money in the U.S. Economy in 2001

Billionsof Dollars

• Currency($580 billion)

• Demand deposits• Traveler’s checks• Other checkable deposits ($599 billion)

• Everything in M1($1,179 billion)

• Savings deposits• Small time deposits• Money market mutual funds• A few minor categories ($4,276 billion)

0

M1$1,179

M2$5,455

Appendix: MONEY STOCK MEASURES • 1. M1 consists of (1) currency outside the U.S. Treasury,

Federal Reserve Banks, and the vaults of depository institutions; (2) traveler's checks of nonbank issuers; (3) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (4) other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions. Seasonally adjusted M1 is constructed by summing currency, traveler's checks, demand deposits, and OCDs, each seasonally adjusted separately.

Appendix: MONEY STOCK MEASURES • 2. M2 consists of M1 plus (1) savings deposits

(including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000), less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds.

• Seasonally adjusted M2 is constructed by summing savings deposits, small-denomination time deposits, and retail money funds, each seasonally adjusted separately, and adding this result to seasonally adjusted M1. (http://www.federalreserve.gov/releases/h6/Current/)

CASE STUDY: Where Is All The Currency?

• In 2001 there was about $580 billion of U.S. currency outstanding.

– That is $2,734 in currency per adult.

• Who is holding all this currency?

– Currency held abroad

– Currency held by illegal entities

3个月 6个月 1年 2年 3年 5年

1990.04.15 2.88 6.3 7.74 10.08 10.98 11.88 13.68

1990.08.21 2.16 4.32 6.48 8.64 9.36 10.08 11.52

1991.04.21 1.8 3.24 5.4 7.56 7.92 8.28 9

1993.05.15 2.16 4.86 7.2 9.18 9.9 10.8 12.06

1993.07.11 3.15 6.66 9 10.98 11.7 12.24 13.86

1996.05.01 2.97 4.86 7.2 9.18 9.9 10.8 12.06

1996.08.23 1.98 3.33 5.4 7.47 7.92 8.28 9

1997.10.23 1.71 2.88 4.14 5.67 5.94 6.21 6.66

1998.03.25 1.71 2.88 4.14 5.22 5.58 6.21 6.66

1998.07.01 1.44 2.79 3.96 4.77 4.86 4.95 5.22

1998.12.07 1.44 2.79 3.33 3.78 3.96 4.14 4.5

1999.06.10 0.99 1.98 2.16 2.25 2.43 2.7 2.88

2002.02.21 0.72 1.71 1.89 1.98 2.25 2.52 2.79

2004.10.29 0.72 1.71 2.07 2.25 2.7 3.24 3.6

2006.08.19 0.72 1.8 2.25 2.52 3.06 3.69 4.14

2007.03.18 0.72 1.98 2.43 2.79 3.33 3.96 4.41

2007.05.19 0.72 2.07 2.61 3.06 3.69 4.41 4.95

2007.07.21 0.81 2.34 2.88 3.33 3.96 4.68 5.22

2007.08.22 0.81 2.61 3.15 3.6 4.23 4.95 5.49

2007.09.15 0.81 2.88 3.42 3.87 4.5 5.22 5.76

2007.12.21 0.72 3.33 3.78 4.14 4.68 5.4 5.85

source: 中国人民银行http://www.pbc.gov.cn/detail.asp?col=462&ID=1902

Table1: 金融机构人民币存款基准利率(单位:年利率％)

定期调整时间活期

调整时间 6个月 1年 1—3 ( )年含 3—5 ( )年含 5年以上

1991. 04. 21 8. 1 8. 64 9 9. 54 9. 72

1993. 05. 15 8. 82 9. 36 10. 8 12. 06 12. 24

1993. 07. 11 9 10. 98 12. 24 13. 86 14. 04

1995. 01. 01 9 10. 98 12. 96 14. 58 14. 76

1995. 07. 01 10. 08 12. 06 13. 5 15. 12 15. 3

1996. 05. 01 9. 72 10. 98 13. 14 14. 94 15. 12

1996. 08. 23 9. 18 10. 08 10. 98 11. 7 12. 42

1997. 10. 23 7. 65 8. 64 9. 36 9. 9 10. 53

1998. 03. 25 7. 02 7. 92 9 9. 72 10. 35

1998. 07. 01 6. 57 6. 93 7. 11 7. 65 8. 01

1998. 12. 07 6. 12 6. 39 6. 66 7. 2 7. 56

1999. 06. 10 5. 58 5. 85 5. 94 6. 03 6. 21

2002. 02. 21 5. 04 5. 31 5. 49 5. 58 5. 76

2004. 10. 29 5. 22 5. 58 5. 76 5. 85 6. 12

2006. 04. 28 5. 4 5. 85 6. 03 6. 12 6. 39

2006. 08. 19 5. 58 6. 12 6. 3 6. 48 6. 84

2007. 03. 18 5. 67 6. 39 6. 57 6. 75 7. 11

2007. 05. 19 5. 85 6. 57 6. 75 6. 93 7. 2

2007. 07. 21 6. 03 6. 84 7. 02 7. 2 7. 38

2007. 07. 21 6. 03 6. 84 7. 02 7. 2 7. 38

2007. 07. 21 6. 03 6. 84 7. 02 7. 2 7. 38

2007. 08. 22 6. 21 7. 02 7. 2 7. 38 7. 56

2007. 09. 15 6. 48 7. 29 7. 47 7. 65 7. 83

2007. 12. 21 6. 57 7. 47 7. 56 7. 74 7. 83

Table2: 金融机构人民币贷款基准利率(单位:年利率％)

Source: 中国人民银行http://www.pbc.gov.cn/detail.asp?col=462&ID=1903

Foreignexchangereserves(100 millionUSD)

Foreignexchangerates (Yuanper USDollar) , (PeriodAverage)

流通中现金Currency incirculation(M0),(Unit:100MillionYuan)

货币Money(M1),(Unit:100MillionYuan)

货币和准货币Money& Quasimoney(M2),(Unit:100MillionYuan)

2003. 12 4032. 51 8. 277 19746. 23 84118. 81 219226. 81

2004. 12 6099. 32 8. 2765 21468. 3 95970. 82 253207. 7

2005. 1 6236. 46 8. 2765 24015. 41 97079. 03 257708. 47

2005. 12 8188. 72 8. 0759 24031. 67 107278. 57 298755. 48

2006. 1 8451. 8 8. 0668 29310. 37 107250. 68 303571. 65

2006. 12 10663. 44 7. 8238 27072. 62 126028. 05 345577. 91

2007. 1 11046. 92 7. 7898 27949. 13 128484. 06 351498. 77

2007. 12 15282. 49 7. 3676 30334. 32 152519. 17 403401. 3

2008. 1 15898. 1 7. 2478 36673. 15 154872. 59 417846. 17

2008. 3 16821. 77 7. 0752 30433. 07 150867. 47 423054. 53

Source: 中国人民银行(www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?file=2008S08.htm)

1985年统一为 10%

1987年从 10%上调为 12%

1988年从 12%上调为 13%

1998年 3月 21日从 12%下调为 8%

1999年 11月 21日从 8%下调为 6%

2003年 9月 21日从 6%上调为 7%

2004年 4月 25日从 7%上调为 7.5%

2006年 7月 5日从 7.5%上调为 8%

2006年 8月 15日从 8%上调为 8.5%

2006年 11月 15日从 8.5%上调为 9%

2007年 1月 15日从 9%上调为 9.5%

2007年 2月 25日从 9.5％上调为 10％2007年 4月 16日从 10％上调为 10.5％2007年 5月 15日从 10.5％上调为 11％2007年 6月 5 从 11％上调为 11.5％

次数公布时间调整前调整后幅度公布后首个交易日沪指表现

15 2008-6-7(端午节) 16.50% 17.50% 1.00% -7.73%

14 2008年5月12日 16% 16.50% 0.50% -1.84%

13 2008年4月16日 15.50% 16% 0.50% -2.09%

12 2008年3月18日 15% 15.50% 0.50% 上涨2.53%

11 2008年1月16日 14.50% 15% 0.50% 下跌2.63%

10 2007年12月8日 13.50% 14.50% 1% 上涨1.38%

9 2007年11月10日 13% 13.50% 0.50% 下跌2.40%

8 2007年10月13日 12.50% 13% 0.50% 上涨2.15%

7 2007年9月6日 12% 12.50% 0.50% 下跌2.16%

6 2007年7月30日 11.50% 12% 0.50% 上涨0.68%

5 2007年5月18日 11% 11.50% 0.50% 上涨1.04%

4 2007年4月29日 10.50% 11% 0.50% 上涨2.16%

3 2007年4月5日 10% 10.50% 0.50% 上涨0.43%

2 2007年2月16日 9.50% 10% 0.50% 上涨1.40%

1 2007年1月5日 9% 9.50% 0.50% 上涨0.94%

存款准备金率上调次日股市的表现与市场自身当时的走势密切相关 (2007年1

月5日至7月30日，股市总体处于快速上涨区间，6次上调准备金率，次日股市都以上涨笑脸相迎。从2007年9月6日到2008年3月18日，股市处于震荡调整期，其间6

次上调准备金率，次日股市则涨跌互现。最近三次上调，即2008年4月16日，5月12日和6月7日，股市次日都报之以较大幅度的下跌。)

29.2 THE FEDERAL RESERVE SYSTEM

• The Federal Reserve (Fed) serves as the nation’s central bank.

– It is designed to oversee the banking system.

– It regulates the quantity of money in the economy.


• The Fed was created in 1914 after a series of bank failures in 1907 convinced Congress that the United States needed a central bank to ensure the health of the nation’s banking system.


• The Structure of the Federal Reserve System:

– The primary elements in the Federal Reserve System are:• 1) The Board of Governors 理事会

• 2) The Regional Federal Reserve Banks

• 3) The Federal Open Market Committee

Board of Governors: Approves discount rates; sets reserve requirements; directs regulatory operations

Federal Open Market Committee (FOMC): Directs open-market operations; advises on discount rate and reserve requirements

Fig 26-2. The Major Players in Monetary Policy

6 6 governors of governors of the the Board

Reserve Bank Reserve Bank Residents

New York York

Chairman of the Board of

Governors

29.2.1 The Fed’s Organization

• The Fed is run by a Board of Governors, which has seven members appointed by the president and confirmed by the Senate.

• Among the seven members, the most important is the chairman.

– The chairman directs the Fed staff, presides over board meetings, and testifies about Fed policy in front of Congressional Committees.


• The Board of Governors– Seven members – Appointed by the president – Confirmed by the Senate– Serve staggered 14-year terms so that one

comes vacant every two years.– President appoints a member as chairman

to serve a four-year term.


• The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C., and twelve regional Federal Reserve Banks.


• The Federal Reserve Banks

– Twelve district banks

– Nine directors

• Three appointed by the Board of Governors.

• Six are elected by the commercial banks in the district.

– The directors appoint the district president, which is approved by the Board of Governors.

The Federal Reserve System


• The Federal Reserve Banks

– The New York Fed implements some of the Fed’s most important policy decisions.


• The Federal Open Market Committee (FOMC)

– Serves as the main policy-making organ of the Federal Reserve System.

– Meets approximately every six weeks to review the economy.


• The Federal Open Market Committee (FOMC) is made up of the following voting members:

– The chairman and the other six members of the Board of Governors.

– The president of the Federal Reserve Bank of New York.

– The presidents of the other regional Federal Reserve banks (four vote on a yearly rotating basis).


• Monetary policy is conducted by the Federal Open Market Committee.

– Monetary policy is the setting of the money supply by policymakers in the central bank

– The money supply refers to the quantity of money available in the economy.

29.2.2 The Federal Open Market Committee

• Three Primary Functions of the Fed

– Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices.

– Acts as a banker’s bank, making loans to banks and as a lender of last resort.

– Conducts monetary policy by controlling the money supply.


• Open-Market Operations

– The money supply is the quantity of money available in the economy.

– The primary way in which the Fed changes the money supply is through open-market operations.

• The Fed purchases and sells U.S. government bonds.



– To increase the money supply, the Fed buys government bonds from the public.

– To decrease the money supply, the Fed sells government bonds to the public.

29.3 BANKS AND THE MONEY SUPPLY

• Banks can influence the quantity of demand deposits in the economy and the money supply.


• Reserves are deposits that banks have received but have not loaned out.

• In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest.


• Reserve Ratio

– The reserve ratio is the fraction of deposits that banks hold as reserves.

29.3.2 Money Creation with Fractional-Reserve Banking

– When a bank makes a loan from its reserves, the money supply increases.

– The money supply is affected by the amount deposited in banks and the amount that banks loan.• Deposits into a bank are recorded as both

assets and liabilities.• The fraction of total deposits that a bank has

to keep as reserves is called the reserve ratio.• Loans become an asset to the bank.


• This T-Account shows a bank that…– accepts deposits,– keeps a portion

as reserves, – and lends out

the rest. – It assumes a

reserve ratio of 10%.

Assets Liabilities

First National Bank

Reserves$10.00

Loans$90.00

Deposits$100.00

Total Assets$100.00

Total Liabilities$100.00


• When one bank loans money, that money is generally deposited into another bank.

• This creates more deposits and more reserves to be lent out.

• When a bank makes a loan from its reserves, the money supply increases.

29.3.3 The Money Multiplier

• How much money is eventually created in this economy?

• The money multiplier is the amount of money the banking system generates with each dollar of reserves.


Assets Liabilities

First National Bank

Reserves$10.00

Loans$90.00

Deposits$100.00

Total Assets$100.00


Assets Liabilities

Second National Bank

Reserves$9.00

Loans$81.00

Deposits$90.00

Total Assets$90.00


Money Supply = $190.00!


• The money multiplier is the reciprocal of the reserve ratio:

M = 1/R

• With a reserve requirement, R = 20% or 1/5,

• The multiplier is 5.

• Thus, the higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier.

供应的影响。币之外其他因素对货币货币乘数反映出基础货。货币乘数大于

应的倍数。基础货币转化为货币供供应的变动。该乘数是的既定变动、货币基础货币为货币乘数，表示对于变量

＝

联系起来很有意义：与基础货币将货币供应造的那部分基础货币。就是由联储贴现贷款创

全控制的部分不能完全控制。不能完完全控制；另一部分则部分联储可以解为两个组成部分：一我们可以把基础货币分

。优于它对储备的控制联储对基础货币的控制一般性的结论是，

数货币供应模型和货币乘

1

MBm

MBmM

MBM

持任何存款。部分，它们不被用来支视作准备金的无效组成准备金。换言之，可以将超额供应也不产生任何影响任何影响，因而对货币会发生，则对存款或通货都不储备被视作超额准备金联储向银行体系注入的如果会产生存款创造。因此以这些超额准备金就不它就不会增加贷款，所时，银行决定持有超额储备任何增加。这是因为当则不会使存款或通货有，备金美元如果转化为超额准增加的是，该等式的另一重要特点

生乘数作用。如果使存款增加，则发则不会发生乘数作用；，如果使通货增加，，基础货币增加的部分存款多倍创造。换言之备金部分那样引起的通货部分并没有像准未变。等额增长，但

增加导致该等式右边增加。这是因为通货的并不能支持存款的任何美元，增加美元所引起的由通货增加该等式的一个特点是，

）（

：加上准备金等于通货）基础货币（

：乘以支票存款数量等于法定准备金率法定准备金总量

：加上超额准备金等于法定准备金）银行系统储备总额（

货币乘数的推导

ERMBb

MBD

MBa

CERDrCRMB

RCMB

DrRR

DrRR

ERRRR

ERRRR

d

d

d

1)(

11)(

2

1

变动。的超额储备率的变动而法定储备率、银行决定率、联储决定的随存款者决定的通货比货币乘数是一个函数，

为，货币乘数

，等于通货加上支票存款货币供应根据定义，

支票存款

)/()/(

)/(1

)/()/(

)/(1

)](1[

)/()/(

1

)]()([)(

1

1

1

DCDERr

DCm

m

MBDCDERr

DCM

DD

CCDM

M

MBDCDERr

D

DD

C

D

ERrCERDrMB

d

d

d

dd

货币乘数。货币乘数大于因而

；

；亿美元；＝亿美元；＝

亿美元；＝＋）＝＝货币供应（

亿美元；＝亿美元；＝亿美元；；入下列变量：认识，将现实的数字代为对货币乘数有一感性

得替代上述表达式中的

协议和隔日欧洲美元。加上隔日回购帐户，金份额和货币市场存款主要是货币市场互助基

定期存款支票存款；流通中的通货；其中，

货币乘数

12

21

1

2

2

2

2

32.8001.05.010.0

5.035.015.2

001.05.010.0

5.01

001.05.0400024000

12000

88000400010.0

)/()/(

)/()/()/(1

)]()()(1[

,

MM

mm

D

ER

D

CMMFT

DCMM

ERDCr

MBDCDERr

DMMFDTDCM

D

DD

MMF

D

T

D

CM

MMF

TDC

MMFTCDM

M

d

d

29.3.4 The Fed’s Tools of Monetary Control

• The Fed has three tools in its monetary toolbox:

– Open-market operations

– Changing the reserve requirement

– Changing the discount rate

1. Open-marketOperations2. Discount rate3. Reserverequirements

1.Money supply2. Interest rate3. Commercial bank’s Reserves

1.Stable prices2. Lowunemployment3. Rapid Growth in real GDP

instruments Intermediate targets Ultimate objectives

Fig29-3. While the Fed Ultimately Pursues Objectives like Stable Prices, Its short-term Operations Focus on the intermediate targets In determining monetary policy, the Fed directly manipulates the instruments or policy variables under its control----open-market operations, the discount rate, and reserve requirements. These help determine bank reserves, the money supply, and interest rates----the intermediate targets of monetary policy. Ultimately, monetary and fiscal policies are partners in pursuing the major objectives of rapid growth, low unemployment, and stable prices. (Samuelson,Economics,18th edition, figure26-3,p534.)



– The Fed conducts open-market operations when it buys government bonds from or sells government bonds to the public:

• When the Fed buys government bonds, the money supply increases.

• The money supply decreases when the Fed sells government bonds.


• Reserve Requirements

– The Fed also influences the money supply with reserve requirements.

– Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits.


• Changing the Reserve Requirement

– The reserve requirement is the amount (%) of a bank’s total reserves that may not be loaned out.

• Increasing the reserve requirement decreases the money supply.

• Decreasing the reserve requirement increases the money supply.


• Changing the Discount Rate

– The discount rate is the interest rate the Fed charges banks for loans.

• Increasing the discount rate decreases the money supply.

• Decreasing the discount rate increases the money supply.

Appendix: The Effects of Money on Output and Prices

B.1. The Monetary Transmission Mechanism

Appendix: The Monetary Transmission Mechanism

• For concreteness, assume that the Federal Reserve is concerned about inflation and has decided to slow down the economy. There are five steps in the process:(Samuelson,Economics,18th edition, pp542-543.)

• 1.To start the process, the fed takes steps to reduce bank reserves for loan. The Fed reduces bank reserves primarily by selling government securities in the open market. This open-market operation changes the balance sheet of the banking system by reducing total bank reserves.

2.Each dollar reduction in bank reserves produces a multiple contraction in checking deposits, thereby reducing the money supply. Since the money supply equals currency plus checking deposits, the reduction in checking deposits reduces the money supply.

• 3.The reduction in the money supply increases interest rates and tightens credit conditions. With an unchanged demand for money, a reduced supply of money will raise interest rates. In addition, the amount of credit (loans and borrowing) available to people will decline. Interest rates will rise for mortgage borrowers and for businesses that want to build factories, buy new equipment, or add to inventories. Higher interest rates tend to reduce asset prices (such as those stocks, bonds, and houses) and therefore depress the values of people's assets.

4. With higher interest rates and lower wealth, interest-sensitive spending--especially investment- - tends to fall. The combination of higher interest rates, tighter credit, and lower wealth tends to reduce investment and consumption spending. Businesses will scale down their investment plans, as will state and local governments. For example, higher interest rates may lead airlines to stretch out their purchases of new aircraft. Similarly, consumers may decide to buy a smaller house, or to renovate their existing one, when rising mortgage interest rates increase monthly payments relative to monthly income. And in an economy increasingly open to international trader, higher interest rates may raise the foreign exchange rate the dollar, depressing net exports. Hence, tight money will raise interest rates and reduce spending on interest-sensitive components of aggregate demand.

• 5. Finally, the pressures of tight money, by reducing aggregate demand, will reduce income, output, jobs, and inflation. The aggregate supply-and-demand (or, equivalently, the multiplier) analysis showed how such a drop in vestment and other autonomous spending may depress output and employment sharply. Furthermore, as output and employment fall below the levels that would otherwise occur, prices tend to rise less rapidly or even to fall. Inflationary forces subside. If the Fed's diagnosis of inflationary conditions was correct, the drop in output and the rise in unemployment will help relieve inflationary forces.

• We can summarize the step as follows:• R down →MS down →i up →I,C,X down →AD down• →Real GDP down and inflation down.

Inte

rest

rat

e (p

erce

nt

per

yea

r)

(a) The Money Market

2

4

6

8

10

Money

D

SB

0

A

M

i

B

SA

10

Investment (per year)

Di

A'

I

i

B'

100 200

2

0

(b) Demand for Investment

3000

3300

S

0

GDP

A"

I, S

B"

100 200

GD

P (

per

year

)

8

4

(c) Output Determined

S

Graphical Analysis of Monetary Policy

Figure 26-7. Central Bank Determines the Money Supply, Changing Interest Rates and Investment, Thereby Affecting GDP.

Appendix: The Effects of Money on Output and Prices

B.2. THE MONEY MARKET

Figure 26-5. The Money Market (Samuelson,Economics,18th edition, p543.)

The interaction of the demand for and supply of money determines the interest rate. The Fed has a money target at M*. The public has a downward-sloping money demand schedule. Here the money market is in equilibrium with a nominal interest rate of 4 percent per year.

2

4

6

8

10

M*

Inte

rest

rat

e (

perc

ent p

er y

ear)

MD

MS

0M

Money

Appendix: Supply of and Demand for Money

Fig26-6. Changes in Monetary Policy or Prices Affect Interest RatesIn (a), the Federal Reserve contracts the money supply in response to fears of rising prices. The lower money supply produces an excess demand for money, shown by the gap NE. As the public adjusts its portfolio, interest rates rise to the new equilibrium at E’. In (b), the demand for money increases as prices rise, other things held constant. The higher demand for money drives up market interest rates until the quantity of money demanded equals the money. (Samuelson, Economics, 18th edition, p544.)

Inte

rest

rat

e (p

erce

nt p

er y

ear)

2

4

6

8

10

M* Money

D

S

0

(a) Monetary Tightening

N

E'

S'

E

M*' M

i

Inte

rest

rat

e (p

erce

nt

per

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ar)

D2

4

6

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M* Money

S

0

(b) Money-Demand Shift

E"

D'E

M

i

• To summarize our findings about the money market:

• the money market is affected by a combination of (1)the public's desire to hold money (represented by the demand-for-money DD curve )and (2)the Fed's monetary policy (shown as a fixed money supply ,SS). their interaction determines the market interest rate. A restrictive monetary policy shifts the SS curve to the left , raising market interest rates. An increase in the nation output or price level shifts the DD curve to the right and raise interest rates .An expansion of the money supply or a decline in money demand has the opposite effects. (Samuelson, Economics, 18th, p545.)

Inte

rest

rat

e (p

erce

nt

per

yea

r)

(a) The Money Market

2

4

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Money

D

SB

0

A

M

i

B

SA

10

Investment (per year)

Di

A'

I

i

B'

100 200

2

0

(b) Demand for Investment

3000

3300

S

0

GDP

A"

I, S

B"

100 200

GD

P (

per

year

)

8

4

(c) Output Determined

S

Graphical Analysis of Monetary Policy

Figure 26-7. Central Bank Determines the Money Supply, Changing Interest Rates and Investment, Thereby Affecting GDP.

• Figure 26-7. Central Bank Determines the Money Supply, Changing Interest Rates and Investment, Thereby Affecting GDP

• When the Fed raises the money supply, from SA to SB, interest rates fall as people increase their money balances, moving down the money demand schedule in (a).

• Lower interest rates reduce the cost of investment, thus encouraging business purchases of plant and equipment and consumer purchases of houses. The economy moves down the demand-for-investment schedule from A' to B' in (b).

• By the multiplier mechanism in (c), the higher investment raises aggregate demand and GDP from A" to B". (Samuelson, Economics,18th edition, P546.)

29.3.5 Problems in Controlling the Money Supply

• The Fed’s control of the money supply is not precise.

• The Fed must wrestle with two problems that arise due to fractional-reserve banking.

– The Fed does not control the amount of money that households choose to hold as deposits in banks.

– The Fed does not control the amount of money that bankers choose to lend.

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Summary

• The term money refers to assets that people regularly use to buy goods and services.

• Money serves three functions in an economy: as a medium of exchange, a unit of account, and a store of value.

• Commodity money is money that has intrinsic value.

• Fiat money is money without intrinsic value.

Summary

• The Federal Reserve, the central bank of the United States, regulates the U.S. monetary system.

• It controls the money supply through open-market operations or by changing reserve requirements or the discount rate.

Summary

• When banks loan out their deposits, they increase the quantity of money in the economy.

• Because the Fed cannot control the amount bankers choose to lend or the amount households choose to deposit in banks, the Fed’s control of the money supply is imperfect.

Problems and Applications

Mankiw-chapter29-p643.:Problem

1. If the Fed wants to increase the money supply with open market operations, what does it so?

2. Why don’t banks hold 100 percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?

3. What is the discount rate? What happens to the money supply when the Fed raises the discount rate?

4. What are reserve requirements?What happens to the money supply when the Fed raises reserve requirements?

5. Why can’t the Fed control the money supply perfectly? (Mankiw-chapter 29, pp640-641.)

Mankiw-chapter29-p643.:Problem

1. What is money multiplier? (Mankiw-chapter 29, p6371.)

2. The Central Bank’s tools of monetary control? (Mankiw-chapter 29, pp640-641.)

3. Describe three functions that money has in the economy? What distinguishes money from other assets in the economy?

4. What is commodity money?What is fiat money? Which kind do we use?

5. What are demand deposits, and why should they be included in the stock of money?

Problems and ApplicationsProblems and Applications

(Mankiw Chapter 32-p730) 1.Explain how each of the following developments would affect the supply of money, the demand for money, and the interest rate. Illustrate your answers with diagrams.

a. A wave of optimism boosts business investment.b. The Central Bank reduces reserve requirements. c. An increase in oil prices shifts the short-run

aggregate-supply curve upward. d. Households decide to hold more money to use for

holiday shopping.

MS

Md

Md'

r1

r2

利率

货币量(c) An increase in oil prices shifts the short-run An increase in oil prices shifts the short-run aggregate-supply curve upward. High price increase the aggregate-supply curve upward. High price increase the demand for money and increase interest rate.demand for money and increase interest rate.

P

Q

AS

AS'

AD

P1

P2

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 2. Suppose banks install automatic teller machines on every block and, by making cash readily avaibable, reduce the amount of money people want on hold.a. Assume the Fed does not change the money supply. According to the theory of liquidity preference, what happens to the interest rate? What happens to aggregate demand?b. If the Fed wants to stabilize aggregate demand, how should it respond?

3.Consider two policies----a tax cut that will last for only one year, and a tax cut that is expected to be permanent. Which policy will stimulate greater spending by consumers? Which policy will have the greater impact on aggregate demand? Explain.

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 4. The interest rate in the United States fell sharply during 1991. Many observers believed this decline showed that monetary policy was quite expantionary during the year. Could this conclusion be incorrect? (Hint:The United States hit the trough of a recession in 1991.)

5. In the early 1980s, new legislation allowed banks to pay interest on checking deposits, which they could not do previously.a. If we define money to include checking deposits, what effect did this legislation have on money demand? Explain.b. If the Federal Reserve had maintained a constant money supply in the face of this change, what would have happened to the interest rate? What would have happen to aggregate demand and aggregate output?C. If the Federal Reserve had maintained a constant market interest rate (the interest rate on nonmonetary assets) in the face of this change, what change in the money supply would have been necessary? What would have happened to aggregate demand and aggregate output?

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 6.This chapter explains that expansionary monetary policy reduces the interest rate and thus stimulates demand for consumption and investment goods. Explain how such policy also stimulates the demand for net exports.

7. Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion.a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?b. Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?

(Mankiw-p731, Chapter 32) 8. Suppose the government reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is 3/4.

a. What is the initial effect of the tax reduction on aggregate demand?　

b. What additional effects follow this initial effect? What is the total effect of the tax cut on aggregate demand?

c. How does the total effect of this $20 billion tax cut compare to the total effect of a $20 billion increase in government purchase? Why?

9. Suppose consumers suddenly become more optimistic about their future incomes and decide to purchase $30 billion of additional goods and services. Will this change have a “multiplied” effect on total output? Explain.

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 10. Suppose government spending increases.Would the effect on aggregate demand be larger if the Federal Reserve took no action in response, or if the Fed were committed to maintaining a fixed interest rate? Explain.

11. In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Explain.a. when the investment accelerator is large or when it is small?b. when the interest sensitivity of investment is large, or when it is small.

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 12. Assume the economy is in a recession. Explain how each of the following policies would affect consumption and investment. In each case, indicate any direct effects, any effects resulting from changes in total output, any effects resulting from changes in the interest rate, and the overall effect. If there are conflicting effects making the answer ambiguous, say so.

a. an increase in government spending b. a reduction in taxes c. an expansion of the money supply

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 13. For various reasons, fiscal policy changes automatically when output and employment fluctuate.

a. Explain why tax revenue changes when the economy goes into a recession.

b. Explain why government spending changes when the economy goes into a recession.

c. If the government were to operate under a strict balanced-budget rule, what would it have to do in a recession? Would that make the recession more or less severe?

(Mankiw Chapter 32 -p731.)(Mankiw Chapter 32 -p731.) 14. In response to an increase in the money supply, would

the following things be smaller, larger, or no different in the long run than in the short run?

a. Consumer expendituresb. The price levelc. The interest rated. Aggregate output

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10 MONEY AND PRICES IN THE LONG RUN Chapter 29 The Monetary System