Chapter 30 - Monetary policy. After reading this chapter, you should be able to: Explain how monetary policy works in the AS/AD model in both the traditional and structural stagnation models, discuss how monetary policy works in practice, discuss the tools of conventional monetary policy, discuss the complex nature of monetary policy and the importance of central bank credibility. | There have been three great inventions since the beginning of time: fire, the wheel and central banking. — Will Rogers Monetary Policy Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Goals Explain how monetary policy works in the AS/AD model in both the traditional and structural stagnation models Discuss how monetary policy works in practice Discuss the tools of conventional monetary policy Discuss the complex nature of monetary policy and the importance of central bank credibility 2 Monetary Policy Monetary policy is a policy of influencing the economy through changes in the banking system’s reserves that influence the money supply, credit availability, and interest rates in the economy Fiscal policy is controlled by the government directly Monetary policy is controlled by the . central bank, the Federal Reserve Bank (the Fed) Monetary policy works through its influence on credit conditions and the interest rate in the economy 3 How Monetary Policy Works in the Models Price level Real output AD0 P0 AD1 P1 Y0 Y1 SAS Monetary policy affects both real output and the price level AD2 Expansionary monetary policy shifts the AD curve to the right Contractionary monetary policy shifts the AD curve to the left Y2 P2 4 How Monetary Policy Works in the Models Expansionary monetary policy is a policy that increases the money supply and decreases the interest rate and it tends to increase both investment and output Contractionary monetary policy is a policy that decreases the money supply and increases the interest rate, and it tends to decrease both investment and output M i I Y M i I Y 5 Monetary Policy and the Fed A central bank is a type of banker’s bank whose financial obligations underlie an economy’s money supply The central bank in the is the Fed If commercial banks need to borrow money, they go to the central bank If there’s a financial panic and a run on banks, the central bank is there to make loans The . | There have been three great inventions since the beginning of time: fire, the wheel and central banking. — Will Rogers Monetary Policy Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter Goals Explain how monetary policy works in the AS/AD model in both the traditional and structural stagnation models Discuss how monetary policy works in practice Discuss the tools of conventional monetary policy Discuss the complex nature of monetary policy and the importance of central bank credibility 2 Monetary Policy Monetary policy is a policy of influencing the economy through changes in the banking system’s reserves that influence the money supply, credit availability, and interest rates in the economy Fiscal policy is controlled by the government directly Monetary policy is controlled by the . central bank, the Federal Reserve Bank (the Fed) Monetary policy works through its influence on credit conditions and the interest rate in the economy 3
