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Review of Monetary Policy

Review of Monetary Policy. First, a few points from Ch.22. Fluctuations in US Real GDP, 1920-2007. What if we take the trend out Short-Run Fluctuations (business cycle). So, you see positive & negative gaps. What happens in the business cycle. Inflation generally decreases in a recession.

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Review of Monetary Policy

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  1. Review of Monetary Policy

  2. First, a few points from Ch.22

  3. Fluctuations in US Real GDP, 1920-2007

  4. What if we take the trend outShort-Run Fluctuations (business cycle)

  5. So, you see positive & negative gaps

  6. What happens in the business cycle Inflation generally decreases in a recession

  7. Unemployment generally increases in a recession

  8. What happens in the business cycle? • Output gap is the difference between potential GDP (output trend, long-term growth path) and actual GDP • Recessionary gap (recession): actual GDP < potential GDP • Inflation low • Unemployment high (high cyclical unemployment) • Expansionary gap : actual GDP > potential GDP (output rises too fast) • Inflation high • Unemployment low (little cyclical unemployment)

  9. Policy Question • What should the Fed do? Ch.24 • First, need to know Fed objectives for its monetary policy • Ask the book author & now Fed Chairman

  10. What to do in a recession? • Spending (& GDP) generally falls in a recession • Inflation falls • Unemployment rises • The Fed can raise the money supply, so… • Fed funds rate/discount rate will fall • Other interest rates will fall • Investment/consumption spending will rise • Production (GDP) will rise

  11. See the Fed’s reaction (function) in this business cycle … it is trying

  12. Is there any downside? • Remember: we are talking about only the short run so far • In the long run, the economy (long-term economic growth) is determined by real factors (Ch.19), not MONEY • In the long run, too much money leads to only inflation (Ch. 21--Quantity Theory of Money) • Is this just a myth? Let’s see what happens if you try…

  13. A tale of Zimbabwe

  14. Money is sometimes evil

  15. What’s Ahead • Nov 17: Foreign Exchange, Ch. 27 • Nov 24: Trade & Capital Flow, Ch. 28 • Dec 1: Review • Review for exam • Where all material fits in the program • Take-Home Exam • April 22: Assignment due (monetary policy)

  16. Video: What if there’s too much money?

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