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ECON302: Money, Banking, And Financial Markets

Unit 6: Monetary Theory   Monetary theory is the study of the effect of money on the economy.  Over time, various theories have evolved to explain the demand for money.  These include the classical theories of Irving Fisher, Alfred Marshall, and A. C. Pigou; the Keynesian theories of the mid-twentieth century; and, finally, the modern quantity theory associated with Milton Friedman.  The extent to which the demand for money is affected by interest rates is one of the central questions in monetary theory; accordingly, it will be addressed in this unit.  

Unit 6 Time Advisory
This unit should take you 24 hours to complete.

☐    Subunit 6.1: 2.5 hours

☐    Subunit 6.2: 4.0 hours

☐    Subunit 6.3: 2.0 hours

☐    Subunit 6.4: 3.0 hours

☐    Subunit 6.5: 3.0 hours

☐    Subunit 6.6: 3.0 hours

☐    Subunit 6.7: 3.5 hours

☐    Assessments: 3 hours

Unit6 Learning Outcomes
Upon successful completion of this unit, the student will be able to:
- Explain what is meant by the demand for money.

  • Identify the factors that affect the demand for money.
  • Explain how money works in the economy using the ISLM framework.
  • Explain the difference between activist and non-activist monetary policy.
  • Explain effective monetary policy.
  • Contrast the effectiveness of monetary policy with fiscal policy.
  • Identify the difference between the Keynesians and the monetarists.
  • Describe the link between money and inflation.
  • Describe how expectations affect the impact the effectiveness of monetary policy.

6.1 The Demand for Money   Note: This subunit discusses the major developments in the theory of the demand for money in chronological order.  These developments have attempted to explain the reasons people hold money and to what extent the quantity of money demanded is affected by changes in interest rates.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 22: The Demand for Money” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 22: The Demand for Money” Lecture Notes (Microsoft Powerpoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 22" link to download the presentation. Please read all of the slides for Chapter 22 for information that covers sections 6.1.1-6.1.5
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 20: Money Demand” Link: Money and Banking: “Chapter 20: Money Demand” (PDF)

    Instructions: Please note this reading will cover the subjects in subunits 6.1.1-6.1.5.  When you click on the link above, you will be directed to “Chapter 20: Money Demand” of an on-line book Money and Banking.  Please read Chapter 20 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: Vimeo.com: Stephen Kinsella’s “Lecture 8: Theories of Money Demand” Video Lecture Link: Vimeo.com: Stephen Kinsella’s “Lecture 8: Theories of Money Demand”Video Lecture (Adobe Flash)
     
    Instructions: This video will cover sections 6.1.1-6.1.5.  When you click on the link above, you will be directed to Stephen Kinsella’s “Lecture 8: Theories of Money Demand” hosted on Vimeo’s website.  Please watch the video (about an hour and 9 minutes) in its entirety.
     
    Note on the Media: The lecturer for this video, Stephen Kinsella, teaches economics at the University of Limerick.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Assessment: Pearson Education: Frederic S. Mishkin’s “Chapter 22: The Demand for Money”: “Multiple Choice Quiz” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 22: The Demand for Money”: “Multiple Choice Quiz” (HTML)
     
    Instructions: This quiz will assess what you have learned in subunits 6.1.1-6.1.5.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 22: The Demand for Money.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to check your answers.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.1.1 The Quantity Theory of Money   6.1.2 Is Velocity a Constant?   6.1.3 Keynes Liquidity Preference Theory   6.1.4 Friedman’s Monetary Quantity Theory of Money   6.1.5 Distinguishing Between the Friedman and Keynesian Theories   6.2 The Keynesian Framework and the ISLM Model   Note: This subunit presents the simple Keynesian model and introduces the ISLM model of simultaneous money and goods markets equilibrium.  These models allow us to better understand the functioning of the economy and to better assess the effects of fiscal and monetary policy actions.  In addition, the ISLM model is used to derive the aggregate demand curve that is used in aggregate demand and supply analysis.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 23: The Keynesian Framework and the ISLM Model” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 23: The Keynesian Framework and the ISLM Model” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 23" link to download the presentation. Please read all of the slides for Chapter 23 for information that covers sections 6.2.1-6.2.3.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 21: IS – LM” Link: Money and Banking: “Chapter 21: IS – LM” (PDF)

    Instructions: This reading will cover topics outlined in sections 6.2.1-6.2.3.  When you click on the link above, you will be directed to “Chapter 21: IS – LM” of an on-line book Money and Banking.  Please read Chapter 21 in its entirety.
     
    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: YouTube: Micoschwartz’s “ISLM Video Tutorial” Link: Micoschwartz’s “ISLM Video Tutorial” (YouTube)
     
    Instructions: Please note this video addresses material covered in sections 6.2.1-6.2.3.  When you click on the link above, you will be directed to Micoschwartz’s “ISLM Video Tutorial” hosted on YouTube.  Please watch the video (5:20 minutes) in its entirety.
     
    Note on the Media: This video provides visual representations of the Hicks-Hansel Model of Keynes’s Theory of Aggregate Demand, focusing on the IS-LM interpretation.  This tutorial is based off of the concepts in the book, Macroeconomics, 7thedition by Dornbusch, Fischer, Startz, Atkins, and Sparks.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.2.1 Determining of Aggregate Output   6.2.2 The ISLM Model   6.2.3 ISLM Approach to Aggregate Output and Interest Rates   - Assessment: Pearson Education: Frederic S. Mishkin’s Multiple Choice Quiz on “Chapter 23: The Keynesian Framework and the ISLM Model” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 23: The Keynesian Framework and the ISLM Model”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 6.2.1-6.2.3.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 23: The Keynesian Framework and the ISLM Model.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to redirect to the answer key.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.3 Monetary and Fiscal Policy in the ISLM Model   Note: In this section, we explore the mechanics of the ISLM model, discovering how monetary policy—the control of the money supply and interest rates—and fiscal policy—the control of government spending and taxes—affect the level of aggregate output and interest rates.  Because policymakers have these two tools at their disposal, they will be interested in knowing the effects each policy can be expected to have on the economy.  The ISLM model provides a convenient and powerful framework for comparing the relative effects of proposed monetary and fiscal actions.  By comparing these predicted effects, policymakers can better decide which policy is most appropriate.

6.3.1 Factors that Cause the IS Curve to Shift   6.3.2 Factors that Cause the LM Curve to Shift   6.3.3 Changes in Equilibrium Level of the Interest Rate and Aggregate Output   6.3.4 Effectiveness of Monetary Versus Fiscal Policy   - Assessment: Pearson Education: Frederic S. Mishkin’s Multiple Choice Quiz on “Chapter 24: Monetary and Fiscal Policy in the ISLM Model” Link: Pearson Education: Frederic S. Mishkin’s Multiple Choice Quiz on “Chapter 24: Monetary and Fiscal Policy in the ISLM Model” (HTML)
 
Instructions: This quiz will assess what you have learned in subunits 6.3.1-6.3.4.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 24: Monetary and Fiscal Policy in the ISLM Model.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to check your answers.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.4 Aggregate Demand and Supply Analysis   Note: This subunit develops the basic tool of aggregate demand and supply analysis in order to study the effects of money on aggregate output and the price level.  The model is very powerful in gaining insight into the workings of the economy, yet it is relatively simple and, with a little work, relatively easy to master.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 25: Aggregate Demand and Supply Analysis” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 25: Aggregate Demand and Supply Analysis” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 25" link to download the presentation. Please read all of the slides for Chapter 25 for information that covers sections 6.4.1-6.4.3.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 23: Aggregate Supply and Demand, the Growth Diamond, and Financial Shocks” Link: Money and Banking: “Chapter 23: Aggregate Supply and Demand, the Growth Diamond, and Financial Shocks” (PDF)

    Instructions: This reading will address the topics in sections 6.4.1-6.4.3.  When you click on the link above, you will be directed to “Chapter 23: Aggregate Supply and Demand, the Growth Diamond, and Financial Shocks” of an on-line book Money and Banking. Please read Chapter 23 in its entirety.
     
    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: YouTube: BrynJonesOnline’s “Aggregate Demand & Aggregate Supply” Video Link: BrynJonesOnline’s “Aggregate Demand & Aggregate Supply”Video (YouTube)
     
    Instructions: This video will cover topics in sections 6.4.1-6.4.3.  When you click on the link above, you will be directed to a video on “Aggregate Demand & Aggregate Supply.”  Please watch the brief video (4:13 minutes) in its entirety.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Lecture: The Khan Academy's "Keynesian Cross" Link: The Khan Academy's "Keynesian Cross" (YouTube).

    Instructions: Please watch this entire video lecture (9:20).

    Terms of Use: This video is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 United States License.  This video was created by Salman Khan for the Khan Academy.

  • Lecture: The Khan Academy's "Details on Shifting Aggregate Planned Expenditures" Link: The Khan Academy's "Details on Shifting Aggregate Planned Expenditures" (YouTube).

    Instructions: Please watch this entire video lecture (11:45).

    Terms of Use: This video is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 United States License.  This video was created by Salman Khan for the Khan Academy.

  • Lecture: The Khan Academy's "Keynesian Cross and the Multiplier" Link: The Khan Academy's "Keynesian Cross and the Multiplier" (YouTube).

    Instructions: Please watch this entire video lecture (10:27).

    Terms of Use: This video is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 United States License.  This video was created by Salman Khan for the Khan Academy.

6.4.1 Three Views of Aggregate Demand (Monetarist, Keynesian, and Crowding-Out)   6.4.2 Aggregate Supply and Shifts in the Curve   6.4.3 Equilibrium in Aggregate Supply and Aggregate Demand   - Assessment: Pearson Education: Frederic S. Mishkin’s “Chapter 25: Aggregate Demand and Supply Analysis”: “Multiple Choice Quiz” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 25: Aggregate Demand and Supply Analysis”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 6.4.1-6.4.3.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 25: Aggregate Demand and Supply Analysis.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to redirect to the answer key.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.5 Transmission Mechanisms of Monetary Policy: The Evidence   Note: This subunit examines the connection between monetary policy and economic activity, focusing on the debate between the monetarists and the Keynesians over the years since the Great Depression, as well as it illustrates how the accumulation of evidence has led to greater consensus regarding the importance of monetary policy on economic activity.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 26" link to download the presentation. Please read all of the slides for Chapter 26 for information that covers sections 6.5.1-6.5.4.

      
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 24: Monetary Policy Transmission Mechanisms” Link: Money and Banking: “Chapter 24: Monetary Policy Transmission Mechanisms” (PDF)

    Instructions: This reading covers topics outlined in sections 6.5.1-6.5.4.  When you click on the link above, you will be directed to “Chapter 24: Monetary Policy Transmission Mechanisms” of an on-line book Money and Banking.  Please read Chapter 24 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: for 6.5.1-6.5.4: YouTube: Radiohogan’s “Keynes Versus Friedman” Link: Radiohogan’s “Keynes versus Friedman” (YouTube)
     
    Instructions: The information in this video will cover concepts in subunits 6.5.1-6.5.4.  When you click on the link above, you will be directed to a video on “Keynes Versus Friedman.”  Please watch the short video (8:50 minutes) in its entirety.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.5.1 Framework for Evaluating Empirical Evidence   6.5.2 Early Evidence on the Importance of Money (Keynesian)   6.5.3 Early Evidence on the Importance of Money (Monetarist)   6.5.4 Transmission Mechanisms for Monetary Policy   - Assessment: Pearson Education: Frederic S. Mishkin’s “Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence”: “Multiple Choice Quiz” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in subunits 6.5.1-6.5.4.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 26: Transmission Mechanisms of Monetary Policy: The Evidence.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to check your answers.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.6 Money and Inflation   Note: In this subunit, the aggregate demand and supply analysis is used to examine the role of monetary policy in creating inflation.  It will be shown that sustained inflation is always the result of sustained growth in the money supply.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 27: Money and Inflation” Lecture Notes Link: Pearson Education Canada's version of Frederic S. Mishkin’s “Chapter 27: Money and Inflation” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 27" link to download the presentation. Please read all of the slides for Chapter 27 for information that covers sections 6.6.1-6.6.5. 

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 25: Inflation and Money” Link: Money and Banking: “Chapter 25: Inflation and Money” (PDF)

    Instructions: This reading will cover concepts from subunits 6.6.1-6.6.5.  When you click on the link above, you will be directed to “Chapter 25: Inflation and Money” of an on-line book Money and Banking.  Please read Chapter 25 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Reading: Boundless: “Analyzing Inflation with the Quantity Theory of Money” Link: Boundless: “Analyzing Inflation with the Quantity Theory of Money” (HTML)
     
    Instructions: Read all nine sections found within this link.
     
    Terms of Use: This resource is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License. It is attributed to Boundless.

6.6.1 Money and Inflation: Historical Evidence   6.6.2 The Meaning of Inflation   6.6.3 Views of Inflation (Monetarist, Keynesian, Others)   6.6.4 Origins of Inflationary Monetary Policy   6.6.5 Activist/Non-Activist Policy Debate   - Assessment: Pearson Education: Frederic S. Mishkin’s “Chapter 27: Money and Inflation”: “Multiple Choice Quiz” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 27: Money and Inflation”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in subunits 6.6.1-6.6.5.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 27: Money and Inflation.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to check your answers.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.7 Rational Expectations: Implications for Policy   Note: This subunit discusses the implications of rational expectations theory for macroeconomic stabilization policies.  Rational expectations theory arose in the 1970s as an attempt to explain "stagflation" and the failure of government policies to prevent this unhappy state.  How can the apparent ineffectiveness of government stabilization policies be explained?  This section introduces models that attempt to answer this question.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 28: Rational Expectations: Implications for Policy” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 28: Rational Expectations: Implications for Policy” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 28" link to download the presentation. Please read all of the slides for Chapter 28 for information that covers sections 6.7.1-6.7.5.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 26: Rational Expectations Redux: Monetary Policy Implications” Link: Money and Banking: “Chapter 26: Rational Expectations Redux: Monetary Policy Implications” (PDF)

    Instructions: This reading will cover topics in subunits 6.7.1-6.7.5.  When you click on the link above, you will be directed to “Chapter 26: Rational Expectations Redux: Monetary Policy Implications” of an on-line book Money and Banking.  Please read Chapter 26 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: YouTube: ignousoss’s “Rational Expectations” Video Link: ignousoss’s “Rational Expectations”Video (YouTube)
     
    Instructions: When you click on the links above, you will be directed to a video on “Rational Expectations.”  Please watch the video (43:47 minutes) in its entirety.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

6.7.1 Lucas Critique of Policy Evaluation   6.7.2 New Classical Macroeconomic Model   6.7.3 New Keynesian Model   6.7.4 Comparison of the Two New Models with the Traditional Model   6.7.5 Impact of Rational Expectations Revolution   - Assessment: Pearson Education: Frederic S. Mishkin’s “Chapter 28: Rational Expectations: Implications for Policy”: “Multiple Choice Quiz” Link: Pearson Education: Frederic S. Mishkin’s “Chapter 28: Rational Expectations: Implications for Policy”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 6.7.1-6.7.5.  When you click on the link above, you will be directed to Frederic S. Mishkin’s multiple choice quiz on “Chapter 28: Rational Expectations: Implications for Policy.”  After you finish the 15 questions of the quiz, please click “Submit Answers for Grading” to check your answers.
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.