• <b>United States Federal Reserve</b>

Principles of Macroeconomics

Monetary Theory

Here we discuss the influence that monetary policy can have on the business cycle. Monetary policy refers to actions taken by the central bank of a country to increase or decrease the supply of money. We develop a model of money supply and money demand, and show how changes in the supply of money influence the interest rate in equilibrium. We combine this model with the aggregate supply / aggregate demand model to show how changes in the market for money influence real GDP and price level. The last pencasts in this series demonstrate how macroeconomic problems may be remedied with monetary policy actions.

[Download PDF]

Money Demand

In this introductory pencast, we define nominal money and real money, and develop a model of demand for money that depends on the interest rate. Households can decide to keep their wealth in money, which can be used for purchases at a later date, or they can keep their wealth in financial assets which earn interest. The higher is the interest rate, the larger is the opportunity cost of holding financial wealth in money, and therefore the lower will be the quantity of money demanded. [Play Pencast]

[Download PDF]

Money Supply and Money Market Equilibrium

Here we introduce the concept of money supply and show how the interest rate and quantity of money are determined in equilibrium along with the demand for money. We show how the central bank can change the money supply, thereby changing the interest rate in equilibrium. [Play Pencast]

[Download PDF]

Shifts in the Demand For Money

The money demand curve is downward sloping, meaning that individuals' decisions to hold money is negatively related to the interest rate. If something besides the interest rate were to influence people's decisions or ability concerning how much money to hold, this will cause a shift in the money demand curve. We explore two factors that can shift the money demand curve. We will demonstrate how shifts in the money demand curve result in changes in the equilibrium interest rate.[Play Pencast]

[Download PDF]

Monetary Policy: Recessionary Gap

Here we start with an economy in a recession (more specifically, a recessionary gap is demonstrated with an aggregate supply / aggregate demand model). We show how the right monetary policy action can alleviate the recession.[Play Pencast]

[Download PDF]

Monetary Policy: Inflationary Gap

Here we start with an economy experiencing a high price level and production bubble. We use the aggregate supply and aggregate demand model to illustrate an economy starting with a high price level and with real GDP above potential GDP, which is by definition, unsustainable. This situation is sometimes called an inflationary gap. We show how the right monetary policy action can push down the price level and bring real GDP closer to potential GDP.[Play Pencast]

Return to Principles of Macroeconomics Home