Ch 14. Monetary Policy

The Money Market

Demand for money

Supply of money

Exhibit 1 Page 299

Equilibrium In The Money Market

Exhibit 2 Page 300

Equilibrium in the money market.

Excess supply of money

Excess demand for money

Transmission Mechanism

The routes, or channels, that ripple effects created in the money market travel to affect the goods and services market (represented by the aggregate demand and aggregate supply curves in the AD – AS framework).

The Keynesian Transmission Mechanism: Indirect The Keynesian route between the money

market and the goods and services market is an indirect one.

Keynesian transmission mechanism is described market by market by the following:

1. The money market. 2. The investment goods market. 3. The goods and services market (AD-AS) framework.

The Keynesian Transmission Mechanism Exhibit 3 Page 301

Money market: - an increase in the money supply

Investment goods market: - investment increases

Goods and services market: - investment increases, total expenditure rise, aggregate demand curve shifts rightward.

The Monetarist Transmission Mechanism: Direct There is a direct link between the money market and

the goods and service market.

Change in the money market have a direct impact on aggregate demand.

Exhibit 6 Page 306.

Money market: - increase money supply

Goods and services market: - increase AD

Monetary Policy And A Recessionary Gap Exhibit 7 Page 307

- Exhibit 7a. The economy is in a recessionary gap, point 1.

- Exhibit 7b. By itself the economy may eventually move to point 2 (take time) by shift SRAS.

- Exhibit 7c. with an appropriate increase in the money supply, AD curve shift right.

Monetary Policy And A Recessionary Gap Exhibit 8 Page 308

- Exhibit 8a. Economy is in an inflationary gap, point 1.

- Exhibit 8b. By itself the economy would eventually move to point 2 by shift left SRAS.

- Exhibit 8c. with an appropriate decrease in the money supply, AD curve shift left.

Expansionary Monetary Policy And No Change In Real GDP Exhibit 9 Page 311

- Expansionary monetary policy is anticipated

(higher price level is anticipated)

workers may bargain for and receive higher

wage rates.