Overview
Purpose:
To discuss the relationship between the money supply and economic growth and inflation, and to illustrate some of the reason why choosing the correct monetary policy is so difficult.
Objectives:
1. Interest rates are affected by the supply and demand for money. The money supply is largely controlled by the Federal Reserve. The demand for money is affected by the level of GNP (transactions demand) and the level of interest rates.
2. High interest rates can be due to either an increase in th dmand for money or a decrease in the supply of money. Therefore, it is not always possible to determine the proper monetary policy by simply following a money supply rule.
3. The quantity of money necessary to support a given level of GNP can change from year to year. Therefore, it is not always possible to determine the proper monetary policy by simply following a money supply rule.
4. The debate between Keynesians and Monetarists has centered on how money affects the economy and whether the Fed should try to target the growth in the money supply or the level of interest rates.
| Key Economic Concepts demand for money,
income velocity of money, accommodative monetary policy, interest rate versus monetary aggregates targets, interest sensitivity of investment, housing and consumer durables. |
| Contemporary Issues In recent years, the Fed has come under severe criticism for not taking pre-emptive action to prevent the stock market bubble of the late 1990s. Does the Fed’s charter include – either explicitly or implicitly – the mandate to control movements in the stock market or other asset markets? Do rising stock prices have an impact on economic behavior – specifically economic growth and inflation? If so, how successful might the Fed be in controlling the movements in the stock market? |
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