The main contents of this chapter include all of the following: Monetary theory, tradeoff faced by the Fed, economic indicators monitored by the Fed, lags in monetary policy, assessing the impact of monetary policy, integrating monetary and fiscal policies, global effects of monetary policy. | Chapter 5 Monetary Theory and Policy Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. Chapter Outline Monetary theory Tradeoff faced by the Fed Economic indicators monitored by the Fed Lags in monetary policy Assessing the impact of monetary policy Integrating monetary and fiscal policies Global effects of monetary policy Monetary Theory Pure Keynesian Theory One of the most popular theories influencing the Fed Developed by John Maynard Keynes Suggests how the Fed can affect the interaction between the demand for money and the supply of money to influence: Interest rates The aggregate level of spending Economic growth Monetary Theory (cont’d) Pure Keynesian Theory (cont’d) Can be explained by using the loanable funds framework Demand for and supply of loanable funds determine the equilibrium interest rate The business investment schedule illustrates the inverse relationship between interest rates on loanable funds and the level of business investment Monetary Theory (cont’d) Pure Keynesian Theory (cont’d) Correcting a weak economy The Fed would use open market operations to increase the money supply A higher level of the money supply would reduce interest rates Lower interest rates encourage more borrowing and spending Keynesian philosophy advocates an active role for the government in correcting economic problems Monetary Theory (cont’d) S2 Correcting a Weak Economy D1 i2 i1 S1 Demand and Supply of Loanable Funds Business Investment Schedule i1 i2 B1 B2 Monetary Theory (cont’d) Pure Keynesian Theory (cont’d) Correcting high inflation The Fed would sell Treasury securities (decrease the money supply) A lower level of the money supply reduces the level of spending Less spending slows economic growth and reduces inflationary pressure (demand-pull inflation) Monetary Theory (cont’d) S1 Correcting High Inflation D1 i1 i2 S2 Demand and Supply of Loanable . | Chapter 5 Monetary Theory and Policy Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. Chapter Outline Monetary theory Tradeoff faced by the Fed Economic indicators monitored by the Fed Lags in monetary policy Assessing the impact of monetary policy Integrating monetary and fiscal policies Global effects of monetary policy Monetary Theory Pure Keynesian Theory One of the most popular theories influencing the Fed Developed by John Maynard Keynes Suggests how the Fed can affect the interaction between the demand for money and the supply of money to influence: Interest rates The aggregate level of spending Economic growth Monetary Theory (cont’d) Pure Keynesian Theory (cont’d) Can be explained by using the loanable funds framework Demand for and supply of loanable funds determine the equilibrium interest rate The business investment schedule illustrates the inverse relationship between .
