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Monetary Policy
The Price Level is
determined by:
The relationship between
the amount of money in
circulation and the
amount of goods and
services in the economy.
MV = PQ
Banks lend $5 which will buy a
basket of goods and services
$5
Borrowers repay $5 which no longer buys the
same basket of goods and services.
$500
Lenders hate inflation!
IOU
$5
$500
How does soft money
affect prices?
• The supply of silver or greenbacks is greater
than the supply of gold.
• The greater the money supply, the less the
price/value of each dollar.
• If the supply of money increases, prices go
up, each dollar buys less.
• With inflation, lenders are repaid in less
valuable dollars. They lose.
Winners and Losers
Lenders
lose purchasing power
because dollars they
are repaid are less
powerful than those
they loaned
Borrowers
gain purchasing power
because dollars they
repay are less
powerful than those
they borrowed
The Money Supply
• Coins, currency, demand deposits, and other
negotiable accounts in the hands of the
NON-BANK public.
FED actions
• To stimulate the economy, increase the
money supply
• To contract the economy, decrease the
money supply
Three tools of monetary policy
• Discount rate
• Reserve requirement
• Open market operations
How the FED influences the money supply
• Increase the money
supply
– Lower the discount rate
– Lower the reserve
requirement
– Buy bonds
• Decrease the money
supply
– Raise the discount rate
– Raise the reserve
requirement
– Sell bonds
Jefferson and Hamilton
• Jefferson’s political philosophy
• Hamilton’s political philosophy
• Why would Jefferson be against a central
bank?
• Why would Hamilton be for a central bank?
Oz and the Election of 1896
Bryan and McKinley
• The Cross of Gold
• Greenbacks or silver
Hard vs Soft Money
• Hard Money
• Soft Money
– gold
– silver or greenbacks
– prevents inflation
– causes inflation
– benefits lenders
– benefits borrowers
– Republicans favor it
– Democrats favor it
The Logic
• Soft Money (greenbacks or silver) causes
inflation
• Hard money (gold) causes price stability
or deflation
• Borrowers (farmers and workers)like soft
money Lenders (bankers) like hard
money
Helped and Hurt by
Unanticipated Inflation
• The eastern bankers - lenders
• Western farmers - borrowers
• Industrial workers - borrowers
Measurements of Inflation
• Consumer Price Index
• Producer Price Index
• Implicit Price Deflator
Main Points
• The price level is determined by the relationship
between the amount of goods and services in the
economy and the amount of money
• Unanticipated inflation helps debtors and hurts
creditors
• The FED influences the money supply through the
discount rate, reserve requirement, and open
market operations.
• Changes in the money supply influence aggregate
demand.
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