Economics 470/570 - Monetary Theory and Policy

Syllabus for Winter 2007

[Syllabus in pdf format]

Monetary Theory and Policy
Course: Economics 470/570
Professor: Mark Thoma
Office/Hours: PLC 471 on M/W 12:00-1:00 p.m.
Phone/Email: (541) 346-4673, [email protected]
Web Page: http://darkwing.uoregon.edu/~mthoma/

Text: Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 7th edition (Addison Wesley: New York).

Prerequisites: Economics 313 or the equivalent.

GTF, Office Hours, Location, and Email Address:

GTF: Beilei Cai
Office: PLC 446
Office Hours: T/Th 1:00-2:00 p.m. and by appointment
[email protected]

Tests and Grading: There will be two midterm exams and a final.  The midterms will be given Wednesday, January 31^st and Monday, February 26^th.  The final will be given on Friday, March 23^rd from 10:15 a.m. – 12:15 p.m.  No make-up exams will be given.  Each midterm is worth 30% and the final is worth 40%.  Grades will be assigned according to your relative standing in the class.

Homework: Problem sets will be assigned periodically. These are not graded, but it is strongly recommended that you do them since exam questions will be based, in part, upon the problem sets.

Course Outline:

Introduction	Mishkin Text
Introduction	Ch. 1, pgs. 8-13
The Role of Money in the Macroeconomy	Ch. 3, Ch. 4 pgs. 87-90
Central Banking and the Conduct of Monetary Policy
Structure of Central Banks and the Federal Reserve System	Ch. 12
Bank Reserves and the Money Supply	Ch. 13
Determinants of the Money Supply	Ch. 14
Tools of Monetary Policy	Ch. 15
Monetary Theory
The Demand for Money	Ch. 19
The Keynesian Framework	Ch. 20
Monetary and Fiscal Policy	Ch. 21
The AS-AD Model	Ch. 22
Money and Inflation	Ch. 24
Rational Expectations: Theory and Policy Implications	Ch. 25

Video Lectures - Winter 2007

Lecture 1 - Chapter 1, pgs. 8-13; Chapter 3, pgs. 49-52

Lecture 1
Google Video

Lecture 2 - Chapter 3, pgs. 53-61; Chapter 4, pgs. 87-90

Lecture 2
Google Video

Lecture 3 - Chapter 12,  pgs. 311-321

Lecture 3
Google Video

Lecture 4 - Chapter 12,  pgs. 321-330; Chapter 13, pgs. 333-340

Lecture 4
Google Video

Lecture 5 - Chapter 13,  pgs. 340-347

Lecture 5
Google Video

Lecture 6 - Chapter 14,  pgs. 351-367; Chapter 15, pgs. 373-389

Lecture 6
Google Video

Lecture 7 - Chapter 19,  pgs. 493-500

Lecture 7
Google Video

Lecture 8 - Chapter 19,  pgs. 501-510

Lecture 8
Google Video

Lecture 9 - Chapter 20,  pgs. 513-531

Lecture 9
Google Video

Lecture 10 - Chapter 20, pgs. 531-535; Chapter 21, pgs. 539-546

Lecture 10
Google Video

Lecture 11 - Chapter 20, pgs. 546-549

Lecture 11
Google Video

Lecture 12 - Chapter 20, pgs. 549-558

Lecture 12
Google Video

Lecture 13 - Chapter 22, pgs. 561-568

Lecture 13
Google Video

Lecture 14 - Chapter 22, pgs. 569-580; Chapter 24, pgs 613-626

Lecture 14
Google Video

Lecture 15 - Chapter 24, pgs. 626-635; Chapter 25, 639-641

Lecture 15
Google Video

Lecture 16 - Chapter 25, pgs. 641-652

Lecture 16
Google Video

Lecture 17 - Chapter 25, pgs. 652-658

Lecture 17
Google Video

Final Exam Winter 2007

Final and Solution.

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Aggregate Supply
Deficit
Debt
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis

Essay

1. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

2. Explain the Keynesian view of aggregate demand.

3. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

4. Is the economy self-correcting?

5. What causes the SRAS curve to shift? Explain.

6. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

7. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

8. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

9. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

10. Can budget deficits lead to inflation? Explain.

11. Why might governments choose to monetize the debt?

12. Explain the activist and non-activist positions on the use of government policy to stabilize macroeconomic variables such as real output. What problems are encountered in the pursuit of activist policies?

13. Explain and give an example of the Lucas critique. Why is this important?

14. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

15. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

16. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

17. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

18. Suppose the monetary authority wants to reduce the inflation rate. Compare the costs (in terms of output) of reducing inflation in the traditional Keynesian, New Classical, and New Keynesian models. Be sure to cover both an expected and an unexpected change in policy. Why is the credibility of policymakers important?

Class Materials for Lecture 17

Brief Outline of Topics Covered in Lecture 17

Chapter 25 Rational Expectations and Implications for Policy

• Anti-inflation policies
  
  • Traditional model
  • New classical model
    
  • New Keynesian model

• The role of credibility in fighting inflation
  
  • Show with AD-AS and Phillips curve diagrams
    

Materials from class:

Continue with materials posted for lecture 16.

Video:

Lecture 17 - Chapter 25, pgs. 652-658
Google Video

Additional Reading:

• The Changing Dynamics of Inflation
• Students and Faculty Given Free Access to TimesSelect
• Econoblog: Is Democracy the Best Setting For Strong Economic Growth?
• How Productive Are We?
• Inflation and Unemployment II

Application:

This graph is from the San Francisco Fed. It shows the relationship between unemployment and wage inflation:

The accompanying write-up says:

Conventional wisdom holds that when the unemployment rate falls below the NAIRU, wage inflation increases, which eventually feeds through to price inflation. A key question for policymakers is whether this conventional wisdom remains relevant today.

There are a number of potentially mitigating factors that might temper the relevance of this historical relationship. Three factors that have received particular study of late are: (1) mismeasurement of available workers, (2) mismeasurement of the NAIRU, and (3) changes in the sensitivity of wage inflation to the unemployment rate owing to the rising importance and stability of inflation expectations.

Although the measured unemployment rate is quite low, some would argue that it does not fully capture the population available for work. Relative to the late 1990s, the labor force participation rate (LFP) and the employment-to-population ratio remain low, suggesting that there is some room for the total workforce to expand. On the other hand, the aging of the baby boom makes the return to past peaks in LFP or the employment-to-population ratio less than certain.

The NAIRU is difficult to measure and is affected by a number of demographic and institutional factors. There is a wide range of credible estimates of the current NAIRU—4.7 to 5.2—suggesting that labor markets may not be quite as tight as the consensus estimate would imply.

The sensitivity of wage inflation to the unemployment rate depends in part on the inflation expectations of workers. Despite elevated levels of price inflation of late, inflation expectations remain well-contained, likely tempering the magnitude of cost-of-living based wage increases demanded by workers.

The graph is part of the latest Economic Outlook from Mary C. Daly, vice president FRBSF. The entire report is on the continuation page:

Class Materials for Lecture 16

Brief Outline of Topics Covered in Lecture 16

Chapter 25 Rational Expectations and Implications for Policy

• New Classical Macroeconomics Model
  • Effects of unanticipated and anticipated policy
  • Can an expansionary policy lead to a decline in aggregate output?
  • Policy ineffectiveness and implications for policymakers

• New Keynesian Model 
  • Effects of unanticipated and anticipated policy
  • Implications for policymakers

• Comparisons of New Classical, New Keynesian, and Traditional Keynesian Models 
  • Short-Run Output and Price Responses

Materials from class:

Video:

Lecture 16 - Chapter 25, pgs. 641-652
Google Video

Additional Reading:

• Gauging Inflation Expectations - WSJ Washington Wire
• Comments on "Understanding the Evolving Inflation Process" FRB Richmond, Lacker
• Update on China: A Monetary Policymaker's Report - FRBSF, Yellen
• Liquidity and monetary policy - FRB: Speech, Kroszner
• U.S. Economic Outlook - Moskow - Federal Reserve Bank of Chicago
• Understanding the evolving inflation process - FRB Speech, Kohn
• Home Foreclosures May Total 1.5 Million in U.S. as Subprime Bust Deepens
• Varian: Observe, Theorize, Measure, and Test
• Does Relabeling the Hours of the Day Save Energy?

Application:

A report on potential problems in the subprime mortgage securities market:

Crisis Looms in Mortgages, by Gretchen Morgenson, NY Times: ...Investment manias are nothing new... But the demise of [the mortgage securities market] has been broadly viewed as troubling, as it involves the nation’s $6.5 trillion mortgage securities market, which is larger even than the United States treasury market.

Class Materials for Lecture 15

Brief Outline of Topics Covered in Lecture 15

Chapter 24 Money and Inflation

• Debt monetization

• The activist/non-activist debate
  
  • Policy lags and other problems in pursuing activist policies

Chapter 25 Rational Expectations and Implications for Policy

• RE and the Lucas critique

Materials from class:

None for today

Video:

Lecture 15 - Chapter 24, pgs. 626-635; Chapter 25, 639-641
Google Video

Additional Reading:

• Milton Friedman: Why Money Matters
• Kenneth Rogoff: Hedge Fund Transparency and Regulation
• Greenspan's Shadow Needs to Shrink
• Bernanke Says Fannie Mae, Freddie Mac Need to Cut Portfolios, Heed Mission
• Greenspan Predicts 'One-Third Probability' of U.S. Recession This Year

Application:

Productivity and Unit Labor Costs: Revised productivity figures were released today (3/6). The revisions were driven by a large upward revision in labor hours. This had two effects. First, with hours revised upward, output per hour - our measure of productivity - declines. Second, with a decline in productivity, unit labor costs increase. Thus, the other side of this is that with higher labor costs, output prices are more likely to be reset upward. This brings about inflation pressure making the Fed more likely to raise rates at renewed signs of inflation, and less likely to cut rates if signs of weakness show up in the data. (To be clear, the revisions to productivity and labor costs won't be news to the Fed - they were widely advertised and anticipated - so this news is already in the Fed's information set and policy response).

Midterm 2 Solution

Midterm 2 and Solution

Class Materials for Lecture 14

Brief Outline of Topics Covered in Lecture 14

Chapter 22 Aggregate Demand and Supply Analysis

• Shifts in the AS curve
  
  • Shifts in the SRAS
  • Shifts in the LRAS and RBC models

Chapter 24 Money and Inflation

• Inflation
  
  • Monetarist view
  • Keynesian view
  • Supply shocks
  • Always a monetary phenomena?

• How does inflationary policy arise?
  
  • Cost push - demand for higher wages
  • Demand pull - shooting at the wrong target

• Budget deficits and inflation

Materials from class:

Video:

Lecture 14 - Chapter 22, pgs. 569-580; Chapter 24, pgs 613-626
Google Video

Additional Reading:

• Forecasting Recessions
• Bernanke: Globalization May Have Increased Inflation
• Expected Inflation
• Explicit Inflation Targeting as a Commitment Device
• Risk Manager: A Nobel laureate says learning can be costly
• Liquidity and Financial Markets - Tim Geithner - FRB New York
• Fed Doesn't Think Sub-prime Mortgages are a Problem - John Berry
• Long-term fiscal challenges and the economy - Bernanke
• The aging workforce - FRB Gov Kohn

Application:

Ben Bernanke on globalization and monetary policy:

Globalization and Monetary Policy, by Ben Bernanke, FRB: My topic this evening is the implications of ongoing global economic integration “globalization” for short--for U.S. monetary policy.