Unit 25 — Monetary Policy

Play Program

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 GDP/GNP (transactions demand) and the level of interest rates.
  2. High interest rates can be due to either an increase in the demand 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 Fed and other central banks around the world have had relatively good luck with inflation targeting—implicit for the Fed, explicit for some other central banks. Inflation has steadily fallen in the past couple of decades.
  4. Central banks have had less luck in controlling asset bubbles. The U.S. housing bubble of the 2000s is a case in point. By keeping interest rates “too low for too long,” the Fed allowed home prices to rise too much, setting the stage for the subprime crisis.

Audio and Transcripts

Meet the Series Experts

GO >>
Milton Friedman

Milton Friedman

Winner of the 1976 Nobel Prize in Economics for “his achievements in the field of consumption analysis, monetary history, and theory, and for his demonstration of the complexity of stabilization policy.”

See full bio
Robert C. Holland

Robert C. Holland

Economist appointed to the Federal Reserve Board by President Richard Nixon in 1973, serving as Secretary to the Board of Governors from 1973 to 1976.

See full bio
Donald Kohn

Donald Kohn

Vice Chairman of the Board of Governors of the Federal Reserve System, 2006–2010, and Member of the Board of Governors, 2002–2008.

See full bio
Henry S. Reuss

Henry S. Reuss

U.S. Congressman from Wisconsin, 1955–1983, a staunch Democrat known for his progressive stands on a wide range of issues.

See full bio
Frederick H. Schultz

Frederick H. Schultz

Private Investor, owner of Schultz Investments, Vice Chairman of the Board of Governors of the Federal Reserve System, 1979–1982, and member of the Florida House of Representatives, 1963–1970.

See full bio

Study Tools

Calculator

Calculator

Use this web-based calculator to aid in your studies.

WHAT’S YOUR
ECONOMICS IQ?

  1. Many economists today agree that major recessions of the twentieth century can be traced to:

    the Fed's efforts to stem inflation by cutting the rate of growth of the money supply.

    NEXT QUESTION

  2. Monetarists tend to believe that the principal factor affecting business fluctuations is:

    variation in the quantity of money.

    NEXT QUESTION

  3. Assume that Economy X produces only one product: natural gas. Now suppose that the current money in circulation is $10,000 and that nominal NNP for the period is $40,000. Based on these figures, what is the current velocity of money?

    4

    NEXT QUESTION

  4. According to the classical view of the equation of exchange, which of the following two factors are constant?

    velocity and output.

    NEXT QUESTION

  5. The extent to which an increase in the money supply affects the price level depends MOST heavily on:

    the current level of employment.

    NEXT QUESTION

  6. The economic situation experienced by the country in the mid-1970s was different from that in preceding times mainly because:

    we faced high employment coupled with high inflation.

    RESTART QUIZ

Glossary

GO >>

Key Terms