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Chapter 01
Why Study
Money, Banking,
and Financial
Markets?
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Why Study Money, Banking, and
Financial Markets
• To examine how financial markets such as
bond and stock markets work
• To examine how financial institutions such
as banks work
• To examine the role of money in the
economy
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1-3
Part1 Introduction
• Chap1 Why Study Money, Banking and
Financial Markets?
• Chap2 An overviews of the Financial System
• Chap3 What is Money?
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Part2 Financial Markets and Financial
Institutions
• Chap4 Understanding Interest Rates
• Chap5 The Behavior of Interest Rates
• Chap6 Banking
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FIGURE 1 Interest Rates on
Selected Bonds, 1950–2008
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Part3 Central Banking and the
Conduct of Monetary Policy
• Chap7 Structure of Central banks
• Chap8 Multiple Deposit Creation and the
Money Supply Process
• Chap9 Determinants of the Money Supply
• Chap10 Tools of Monetary Policy
• Chap11 What should central Banks Do?
Monetary Policy Goals, Strategy and Tactics
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Part4 Money Theory
• Chap12 The Demand for Money
• Chap13 Aggregate Demand and Supply
Analysis
• Chap14 Transmission Mechanisms of
Monetary Policy: The Evidence
• Chap15 Money and Inflation
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FIGURE 4 Aggregate Price Level and the
Money Supply in the United States, 1950–
2008
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Money and Inflation
• The aggregate price level is the average
price of goods and services in an economy
• A continual rise in the price level (inflation)
affects all economic players
• Data shows a connection between the
money supply and the price level
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FIGURE 5 Average Inflation Rate Versus
Average Rate of Money Growth for Selected
Countries, 1997–2007
Source: International Financial Statistics.
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FIGURE 6 Money Growth (M2 Annual Rate)
and Interest Rates (Long-Term . Treasury
Bonds), 1950–2008
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Money and Interest Rates
• Interest rates are the price of money
• Prior to 1980, the rate of money growth and
the interest rate on long-term Treasury
bonds were closely tied
• Since then, the relationship is less clear but
the rate of money growth is still an
important determinant of interest rates
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FIGURE 3 Money Growth (M2 Annual Rate)
and the Business Cycle in the United States,
1950–2008
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How We Will Study Money,
Banking, and Financial Markets
• A simplified approach to the demand for
assets
• The concept of equilibrium
• Basic supply and demand to explain
behavior in financial markets
• The search for profits
• An approach to financial structure based on
transaction costs and asymmetric
information
• Aggregate supply and demand analysis
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References
• 米什金，《货币金融学》（中文）（8)，清华大学出版社，
2009
• 米什金，《货币金融学》（中文）（9)，人民大学出版社，
2011
• 易纲、吴有昌，《货币银行学》，上海人民出版社，1999年
• 武康平， 《货币银行学教程》清华大学出版社2006年
• 黄达，《货币银行学》， 中国人民大学出版社2000年
• 戴国强，《货币银行学》， 上海财经大学出版社，2003
• 托马斯，《货币，银行业和金融市场》机械工业出版社2008
• R.哈里斯著，梁小民译：《货币理论》，中国金融出版社，
北京，1989
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Chapter 3
What Is Money?
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Meaning of Money（货币）
• What is it?
• Money (or the “money supply”): anything
that is generally accepted in payment for
goods or services or in the repayment of
debts.
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Meaning of Money
• Money (a stock concept) is different from:
• Currency: consist of dollar bills（钞票） and
coins（硬币）, currency is one type of
money.
• Wealth（财富）: the total collection of pieces
of property that serve to store value
• Income（收入）: flow of earnings per unit of
time (a flow concept)
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Functions of Money
• Medium of Exchange（交易媒价）:
– Eliminates the trouble of finding a double
coincidence of needs (reduces transaction costs)
– Promotes specialization
• A medium of exchange must
– be easily standardized
– be widely accepted
– be divisible
– be easy to carry
– not deteriorate quickly
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Functions of Money
• Unit of Account（计算单位）:
– used to measure value in the economy
– reduces transaction costs
• Store of Value（价值尺度）:
– used to save purchasing power over time.
– other assets also serve this function
– Money is the most liquid of all assets but loses
value during inflation
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Evolution of the Payments
System（支付制度的演变）
• Commodity Money（商品货币）: valuable,
easily standardized and divisible
commodities (. precious metals,
cigarettes).
• Fiat Money（不兑现纸币）: paper money
decreed by governments as legal tender（法
定货币）.
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Evolution of the Payments
System
• Checks（支票）: an instruction to your bank
to transfer money from your account
• Electronic Payment (电子支付，. online bill
pay).
• E-Money (electronic money，电子货币):
– Debit card
– Stored-value card (smart card)
– E-cash
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Measuring Money
• How do we measure money? Which
particular assets can be called “money”?
• Construct monetary aggregates using the
concept of liquidity:
• M1 (most liquid assets) = currency（通货）
+ traveler’s checks（旅行支票） + demand
deposits （活期存款）+ other checkable
deposits（其他支票存款）.
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Measuring Money
• M2 (adds to M1 other assets that are not so
liquid) = M1 + small denomination time
deposits（小面额定期存款） + savings
deposits and money market deposit
accounts （储蓄存款和货币市场存款账户）+
money market mutual fund
shares（retail）（货币市场互助基金份额（非机
构持有））.
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Table 1 Measures of the Monetary
Aggregates
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Monetary Aggregates
Currency
Traveler’s Checks
Demand Deposits
Other Check. Dep
M1
M2
M3
Small Den. Dep.
Savings and MM
Money Market Mutual
Funds Shares
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•• 存款的种类：存款的种类：**
•• 活期存款：这种存款，支用时须活期存款：这种存款，支用时须使用银行规定的使用银行规定的
支票支票，又称为支票存款。企业、个人、政府机关、，又称为支票存款。企业、个人、政府机关、
金融机构都能在银行开立活期存款账户。金融机构都能在银行开立活期存款账户。
•• 定期存款：指那些具有确定的到期期限才准提取定期存款：指那些具有确定的到期期限才准提取
的存款。的存款。
•• 储蓄存款：这主要是针对储蓄存款：这主要是针对居民个人居民个人积蓄货币之需积蓄货币之需
所开办的一种存款业务。一般所开办的一种存款业务。一般不能据此签发支票不能据此签发支票，，
支用时只能提取现金或先转入存户的活期存款账支用时只能提取现金或先转入存户的活期存款账
户。它可以进一步分为活期和定期两大类。户。它可以进一步分为活期和定期两大类。
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中国的货币计量：中国的货币计量：
M0 = M0 = 流通中现金流通中现金
M1 = M0 + M1 = M0 + 企事业单位活期存款企事业单位活期存款
M2 = M1 + M2 = M1 + 企事业单位定期存款企事业单位定期存款++居民储蓄存款居民储蓄存款 + +
证券公司客户保证金证券公司客户保证金 + + 其他存款其他存款
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货币概览 Monetary Survey
项目 Items 2005
货币和准货币 Money & Quasi money
货币 Money（M1）
流通中现金 Currency in circulation
活期存款 Demand deposits
准货币 Quasi money
定期存款 Time deposits
储蓄存款 Saving deposits
其他存款 Other deposits
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M1 vs. M2
• Does it matter which measure of money is
considered?
• M1 and M2 can move in different directions
in the short run (see figure).
• Conclusion: the choice of monetary
aggregate is important for policymakers.
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FIGURE 1 Growth Rates of the M1
and M2 Aggregates, 1960–2008
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How Reliable are the Money
Data?
• Revisions are issued because:
– Small depository institutions report infrequently
– Adjustments must be made for seasonal variation
• We probably should not pay much attention
to short-run movements in the money
supply numbers, but should be concerned
only with longer-run movements
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Table 2 Growth Rate of M2: Initial and
Revised Series, 2008 (percent, compounded
annual rate)
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M2
Growth
Rate
GDP
Growth
Rate
2000
2001
2002
2003
2004
2005
2006
2007
均值
M2
Growth
Rate
GDP
Growth
Rate
1991
1992
1993
1994
1995
1996
1997
1998
1999
1991~2007年M2与GDP增长率
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表1 美英德法四国批发物价指数
年份
（1816-1913）
美国 英国 德国 法国
1816 150 147 94 143
1849 82 46 67 94
1873 137 130 114 122
1896 64 72 69 69
1913 100 100 100 100
指数1913=100
数据来源：马君潞：《国际货币制度研究》，
中国财政经济出版社，1995。
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• In 1944, there was a meeting of 44 nations at
Bretton Woods, New Hampshire. The meeting was
called the Bretton Woods Conference,
officially known as the United Nations
Monetary and Financial Conference.
• An international agreement, called Bretton
Woods Agreement, was reached to govern
monetary policy among nations
• The purpose was to design a postwar
international monetary system.
Bretton Woods System:
1945-1972
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• Under the Bretton Woods System, the .
dollar was pegged to gold at $35 per ounce
and other currencies were pegged to the .
dollar.
• Each country was responsible for maintaining
its exchange rate within ±1% of the adopted
par value by buying or selling foreign
reserves as necessary.
• The Bretton Woods System was a dollar-based
gold exchange standard.
Bretton Woods System:
1945-1972
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• 世界出口贸易年平均增长率，
1948—1976年为%，
1913—1938年，平均每年只增长%。
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• On one hand, performing the role of the world's
reserve currency, the US dollar should keep its
value stable.
• On the other hand, the international economy
needed dollars for liquidity purposes and to satisfy
demand for reserve assets. This forced US to run
consistently large current account deficits.
• Triffin argued that such persistent deficits would
eventually put pressure on the US dollar and lead to
the demise of the Bretton Woods system of
international exchange.
Triffin Dilemma
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Chapter 4
Understanding
Interest Rates
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4-45
Discounting the Future( )
……
Present Value（现值）
• Definition （定义）: A dollar paid to you one
year from now is less valuable than a dollar
paid to you today
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Time Line
$100 $110
Year 0 1
PV $100
2
$121
n
Cannot directly compare payments scheduled in different points in the
time line
$100*(1+i)n
$100 $100 $100
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Simple Present Value Formula
（简单的现值公式）
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Time Line
$100 $100
Year 0 1
PV 100
2
$100 $100
n
100/(1+i) 100/(1+i)2 100/(1+i)n
Cannot directly compare payments scheduled in different points in the
time line
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Four Types of Credit Market
Instruments
• Simple Loan（简易贷款）:The lender provides
the borrower with an amount of money, which
must be repaid to the lender at the maturity
date along with an additional payment for the
interest.
• Fixed-Payment Loan（定期定额贷款）:This type
of loan has the same cash flow throughout the
life of the loan.
• Coupon Bond（息票债券）:A coupon bond pays
the owner of the bond a fixed interest rate
(coupon payment) every year until the maturity
date, when a specified final amount is paid.
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4-50
Four Types of Credit Market
Instruments
• Discount Bond（贴现发行债券）:A discount
bond is bought at a price below its face
value (at a discount), and the face value is
repaid at the maturity date.
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Yield to Maturity(到期收益率)
• Definition（定义）：
• The interest rate that equates the
present value of cash flow payments
received from a debt instrument（未来现金流
的现值） with
its value today（今天的价值）
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代表债券价格
代表第t期债券的利息
代表债券的期数
代表债券本金
代表到期收益率
The formula of Yield to
Maturity(到期收益率的公式)
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Table 1 Yields to Maturity on a 10%-
Coupon-Rate Bond Maturing in Ten Years
(Face Value = $1,000)
• When the coupon bond is priced at its face value, the
yield to maturity equals the coupon rate
• The price of a coupon bond and the yield to maturity are
negatively related
• The yield to maturity is greater than the coupon rate
when the bond price is below its face value
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Table 1 Yields to Maturity on a 10%-
Coupon-Rate Bond Maturing in Ten Years
(Face Value = $1,000)
• When the coupon bond is priced at its face value, the
yield to maturity equals the coupon rate
• The price of a coupon bond and the yield to maturity are
negatively related
• The yield to maturity is greater than the coupon rate
when the bond price is below its face value
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Consol(统一公债) or
Perpetuity（永久债券）
• Definition: A bond with no maturity date that does
not repay principal but pays fixed coupon payments
forever
For coupon bonds, this equation gives the current yield, an
easy to calculate approximation to the yield to maturity
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Discount Bond（贴现发行债券）
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Other Measures of Interest
Rates
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Current Yield（当期收益率）
、
C
ic = P
Two Characteristics
• Is better approximation to yield to maturity, nearer price
is to par and longer is maturity of bond
• Change in current yield always signals change in same
direction as yield to maturity
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4-591-59
(F – P) 360
idb = x
F (number of days to maturity)
One year bill, P = $900, F = $1000
$1000 – $900 360
idb = x = = % $1000 365
Two CharacteristicsTwo Characteristics
• Understates yield to maturity; longer the maturity, greater
is understatement
• Change in discount yield always signals change in same
direction as yield to maturity
Yield on a Discount Basis（贴现收益率）
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Bond Page of the Newspaper
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Rate of Return（回报率）
Definiton(定义): the rate of return is defined as the
payments to the owner plus the change in its value.
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Rate of Return and Interest
Rates
• The return equals the yield to maturity only if the
holding period equals the time to maturity
• A rise in interest rates is associated with a fall in
bond prices, resulting in a capital loss if time to
maturity is longer than the holding period
• The more distant a bond’s maturity, the greater the
size of the percentage price change associated with
an interest-rate change
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Rate of Return and Interest
Rates (cont’d)
• The more distant a bond’s maturity, the lower the
rate of return the occurs as a result of an increase
in the interest rate
• Even if a bond has a substantial initial interest rate,
its return can be negative if interest rates rise
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Table 2 One-Year Returns on Different-Maturity
10%-Coupon-Rate Bonds When Interest Rates
Rise from 10% to 20%
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Interest-Rate Risk
• Prices and returns for long-term bonds are
more volatile than those for shorter-term
bonds
• There is no interest-rate risk for any bond
whose time to maturity matches the holding
period
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Real and Nominal Interest
Rates
• Nominal interest rate makes no allowance
for inflation
• Real interest rate is adjusted for changes in
price level so it more accurately reflects the
cost of borrowing
• Ex ante real interest rate is adjusted for
expected changes in the price level
• Ex post real interest rate is adjusted for
actual changes in the price level
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Fisher Equation
• The Relationship between Nominal interest
rate and Real interest rate:
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FIGURE 1 Real and Nominal Interest Rates
(Three-Month Treasury Bill), 1953–2008
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Chapter 5
The Behavior of
Interest Rates
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Determining the Quantity
Demanded of an Asset
• Wealth: the total resources owned by the individual,
including all assets
• Expected Return: the return expected over the next
period on one asset relative to alternative assets
• Risk: the degree of uncertainty associated with the
return on one asset relative to alternative assets
• Liquidity: the ease and speed with which an asset
can be turned into cash relative to alternative
assets
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Theory of Asset Demand
Holding all other factors constant:
1. The quantity demanded of an asset is positively
related to wealth
2. The quantity demanded of an asset is positively
related to its expected return relative to
alternative assets
3. The quantity demanded of an asset is negatively
related to the risk of its returns relative to
alternative assets
4. The quantity demanded of an asset is positively
related to its liquidity relative to alternative
assets
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Summary Table 1 Response of the Quantity of
an Asset Demanded to Changes in Wealth,
Expected Returns, Risk, and Liquidity
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Supply and Demand for
Bonds
• At lower prices (higher interest rates),
ceteris paribus, the quantity demanded of
bonds is higher: an inverse（相反的，负向的）
relationship
• At lower prices (higher interest rates),
ceteris paribus, the quantity supplied of
bonds is lower: a positive relationship
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FIGURE 1 Supply and Demand for
Bonds
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Market Equilibrium
• Occurs when the amount that people are
willing to buy (demand) equals the amount
that people are willing to sell (supply) at a
given price
• Bd = Bs defines the equilibrium (or market
clearing) price and interest rate.
• When Bd > Bs , there is excess demand,
price will rise and interest rate will fall
• When Bd < Bs , there is excess supply, price
will fall and interest rate will rise
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Shifts in the Demand for
Bonds
• Wealth: in an expansion with growing wealth, the
demand curve for bonds shifts to the right
• Expected Returns: higher expected interest rates in
the future lower the expected return for long-term
bonds, shifting the demand curve to the left
• Expected Inflation: an increase in the expected rate
of inflations lowers the expected return for bonds,
causing the demand curve to shift to the left
• Risk: an increase in the riskiness of bonds causes
the demand curve to shift to the left
• Liquidity: increased liquidity of bonds results in the
demand curve shifting right
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Summary Table 2 Factors That
Shift the Demand Curve for Bonds
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FIGURE 2 Shift in the Demand
Curve for Bonds
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Shifts in the Supply of Bonds
• Expected profitability of investment
opportunities: in an expansion, the supply
curve shifts to the right
• Expected inflation: an increase in expected
inflation shifts the supply curve for bonds to
the right
• Government budget: increased budget
deficits shift the supply curve to the right
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Summary Table 3 Factors That
Shift the Supply of Bonds
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FIGURE 3 Shift in the Supply
Curve for Bonds
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FIGURE 4 Response to a Change in
Expected Inflation
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FIGURE 5 Expected Inflation and Interest Rates
(Three-Month Treasury Bills), 1953–2008
Source: Expected inflation calculated using procedures outlined in Frederic S. Mishkin, “The Real
Interest Rate: An Empirical Investigation,” Carnegie-Rochester Conference Series on Public Policy 15
(1981): 151–200. These procedures involve estimating expected inflation as a function of past
interest rates, inflation, and time trends.
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FIGURE 6 Response to a Business
Cycle Expansion
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FIGURE 7 Business Cycle and Interest Rates
(Three-Month Treasury Bills), 1951–2008
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The Liquidity Preference
Framework
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FIGURE 8 Equilibrium in the
Market for Money
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Demand for Money in the
Liquidity Preference Framework
• As the interest rate increases:
– The opportunity cost of holding money
increases…
– The relative expected return of money
decreases…
• …and therefore the quantity demanded of
money decreases.
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Shifts in the Demand for
Money
• Income Effect: a higher level of income
causes the demand for money at each
interest rate to increase and the demand
curve to shift to the right
• Price-Level Effect: a rise in the price level
causes the demand for money at each
interest rate to increase and the demand
curve to shift to the right
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1-91
Shifts in the Supply of Money
• Assume that the supply of money is
controlled by the central bank
• An increase in the money supply engineered
by the Federal Reserve will shift the supply
curve for money to the right
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1-92
FIGURE 9 Response to a Change in
Income or the Price Level
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1-93
FIGURE 10 Response to a Change
in the Money Supply
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1-94
Summary Table 4 Factors That Shift
the Demand for and Supply of Money
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1-95
Everything Else Remaining
Equal?
• Liquidity preference framework leads to the
conclusion that an increase in the money
supply will lower interest rates: the liquidity
effect.
• Income effect finds interest rates rising
because increasing the money supply is an
expansionary influence on the economy (the
demand curve shifts to the right).
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1-96
Everything Else Remaining
Equal?
• Price-Level effect predicts an increase in the
money supply leads to a rise in interest
rates in response to the rise in the price
level (the demand curve shifts to the right).
• Expected-Inflation effect shows an increase
in interest rates because an increase in the
money supply may lead people to expect a
higher price level in the future (the demand
curve shifts to the right).
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1-97
Price-Level Effect
and Expected-Inflation Effect
• A one time increase in the money supply will cause prices to
rise to a permanently higher level by the end of the year. The
interest rate will rise via the increased prices.
• Price-level effect remains even after prices have stopped
rising.
• A rising price level will raise interest rates because people will
expect inflation to be higher over the course of the year. When
the price level stops rising, expectations of inflation will return
to zero.
• Expected-inflation effect persists only as long as the price level
continues to rise.
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1-98
FIGURE 11 Response over Time to an
Increase in Money Supply Growth
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1-99
FIGURE 12 Money Growth (M2, Annual Rate)
and Interest Rates (Three-Month Treasury Bills),
1950–2008
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Chapter 6
Banking
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10-101
Banking
balance sheet
business
Off-balance sheet
activities (OBSA)
Asset Liability OBSA in a
narrow scence
Inter-
business
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The Bank Balance Sheet
• Liabilities
– Checkable deposits
– Nontransaction deposits
– Borrowings
– Bank capital
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Deposits
Deposits
no-interest-bearing checking accounts:
demand deposits
interest-bearing checking accounts:
NOW (negotiable orders of withdrawal )
ATS (automatic transfers from savings)
MMDAs (money market deposit accounts)
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10-104
Deposits
2. Non-transaction Deposits
Savings account
Time deposits
Small-denomination time
deposits(<$100,000)
large-denomination time deposits(≥
$100,000)
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10-105
Borrowings
• Borrowings from The Central Bank
• Borrowings from other bank and financial
institutions
• Repurchase agreements
• Borrowing of Eurodollars
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10-106
Bank Capital
• stock (common stock and preferred stock)
• Surplus
• Undivided profits (retained earnings)
• Reserves
• Debentures
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Assets (uses of funds)
loan
Cash items Other assets
securities
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10-108
The Bank Balance Sheet
• Assets
– Reserves
– Cash items in process of collection
– Deposits at other banks
– Securities
– Loans
– Other assets
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Table 1 Balance Sheet of All Commercial
Banks (items as a percentage of the total,
December 2008)
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Basic Banking: Cash Deposit
• Opening of a checking account leads to an increase
in the bank’s reserves equal to the increase in
checkable deposits
First National Bank First National Bank
Assets Liabilities Assets Liabilities
Vault
Cash
+$100 Checkable
deposits
+$100 Reserves +$100 Checkable
deposits
+$100
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Basic Banking: Check Deposit
First National Bank Second National Bank
Assets Liabilities Assets Liabilities
Reserves +$100 Checkable
deposits
+$100 Reserves -$100 Checkable
deposits
-$100
First National Bank
Assets Liabilities
Cash items in
process of
collection
+$100 Checkable
deposits
+$100
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10-112
Basic Banking: Making a
Profit
• Asset transformation: selling liabilities with one set of
characteristics and using the proceeds to buy assets with a
different set of characteristics
• The bank borrows short and lends long
First National Bank First National Bank
Assets Liabilities Assets Liabilities
Required
reserves
+$100 Checkable
deposits
+$100 Required
reserves
+$100 Checkable
deposits
+$100
Excess
reserves
+$90 Loans +$90
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10-113
Inter-business
• Bank settlement
settlement instrument
check, draft and promissory notes
terms of settlement
settlement by remittance
settlement by collection
settlement by letter of credit
• Finance lease
• Fiduciary business
• Safe deposit box
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10-114
Letter of credit
Issuing Bank/
Buyer’s Bank
Seller/Beneficiary
Advising Bank/
Negotiating Bank
Buyer/Applicant
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10-115
Off-Balance-Sheet Activities
• Loan sales (secondary loan participation)
• Generation of fee income. Examples:
– Servicing mortgage-backed securities.
– Creating SIVs (structured investment vehicles)
which can potentially expose banks to risk, as it
happened in the subprime financial crisis of 2007
-2008.
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10-116
• A guarantee of payment issued by a bank on behalf
of a client that is used as “payment of last resort”
should the client fail to fulfill a contractual
commitment with a third party.
standby letters of credit
（备用信用证）
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10-117
原始贷款发放行 信用担保公司
信用评级公司 信托公司
债券承销商投资者
购买信用担保
信
用
担
保
发
行
债
券
评定信用等级
定价和推销债券
出售贷款和
贷款权力转移
Loan sales
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Chapter 08
The Money
Supply Process
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Players in the Money Supply
Process
• Central bank (Federal Reserve System)
• Banks (depository institutions; financial
intermediaries)
• Depositors (individuals and institutions)
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Fed’s Balance Sheet
• Monetary Liabilities
– Currency in circulation: in the hands of the public
– Reserves: bank deposits at the Fed and vault cash
• Assets
– Government securities: holdings by the Fed that affect
money supply and earn interest
– Discount loans: provide reserves to banks and earn
the discount rate
Federal Reserve System
Assets Liabilities
Government securities Currency in circulation
Discount loans Reserves
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Monetary Base
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Open Market Purchase from
a Bank
• Net result is that reserves have increased by $100
• No change in currency
• Monetary base has risen by $100
Banking System Federal Reserve System
Assets Liabilities Assets Liabilities
Securities -$100 Securities +$100 Reserves +$100
Reserves +$100
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Open Market Purchase from
Nonbank Public I
• Person selling bonds to the Fed deposits the Fed’s
check in the bank
• Identical result as the purchase from a bank
Banking System Federal Reserve System
Assets Liabilities Assets Liabilities
Reserves +$100 Checkable
deposits
+$100 Securities +$100 Reserves +$100
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Open Market Purchase from
Nonbank Public II
• The person selling the bonds cashes the Fed’s check
• Reserves are unchanged
• Currency in circulation increases by the amount of
the open market purchase
• Monetary base increases by the amount of the open
market purchase
Nonbank Public Federal Reserve System
Assets Liabilities Assets Liabilities
Securities -$100 Securities +$100 Currency in
circulation
+$100
Currency +$100
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14-125
Open Market Purchase:
Summary
• The effect of an open market purchase on
reserves depends on whether the seller of
the bonds keeps the proceeds from the sale
in currency or in deposits
• The effect of an open market purchase on
the monetary base always increases the
monetary base by the amount of the
purchase
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14-126
Open Market Sale
• Reduces the monetary base by the amount of
the sale
• Reserves remain unchanged
• The effect of open market operations on the
monetary base is much more certain than the
effect on reserves
Nonbank Public Federal Reserve System
Assets Liabilities Assets Liabilities
Securities +$100 Securities -$100 Currency in
circulation
-$100
Currency -$100
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14-127
Shifts from Deposits into
Currency
Nonbank Public Banking System
Assets Liabilities Assets Liabilities
Checkable
deposits
-$100 Reserves -$100 Checkable
deposits
-$100
Currency +$100
Federal Reserve System
Assets Liabilities
Currency in
circulation
+$100
Reserves -$100
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14-128
Making a Discount Loan to a
Bank
• Monetary liabilities of the Fed have increased by
$100
• Monetary base also increases by this amount
Banking System Federal Reserve System
Assets Liabilities Assets Liabilities
Reserves +$100 Discount
loans
+$100 Discount
loan
+$100 Reserves +$100
(borrowing from Fed) (borrowing from
Fed)
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14-129
Paying Off a Discount Loan
from the Fed
• Net effect on monetary base is a reduction
• Monetary base changes one-for-one with a change
in the borrowings from the Federal Reserve System
Banking System Federal Reserve System
Assets Liabilities Assets Liabilities
Reserves -$100 Discount
loans
-$100 Discount
loans
-$100 Reserves -$100
(borrowing from Fed) (borrowing from
Fed)
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14-130
Other factors that affect the MB
资产(Assets) 负债(Liabilities)
LC：流通中的现金
AB：对银行的债权 LB：银行准备金
AG：对政府的债权 LG：对政府的负债
AF：对国外的债权 LF：对国外的负债
AB：其他资产 LO：其他负债
OC：中央银行自有资本
根据资产等于负债的原理：
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• Open market operations are controlled by the Fed
• The Fed cannot determine the amount of
borrowing by banks from the Fed
• Split the monetary base into two components
MBn= MB - BR
• The money supply is positively related to both the
non-borrowed monetary base MBn and
to the level of borrowed reserves, BR, from
the Fed
Fed’s Ability to Control the
Monetary Base
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14-132
Deposit Creation: Single
Bank
First National Bank First National Bank
Assets Liabilities Assets Liabilities
Securities -$100 Securities -$100 Checkable
deposits
+$100
Reserves +$100 Reserves +$100
Loans +$100
First National Bank
Assets Liabilities
Securities -$100
Loans +$100
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14-133
Deposit Creation:
The Banking System
Bank A Bank A
Assets Liabilities Assets Liabilities
Reserves +$100 Checkable
deposits
+$100 Reserves +$10 Checkable
deposits
+$100
Loans +$90
Bank B Bank B
Assets Liabilities Assets Liabilities
Reserves +$90 Checkable
deposits
+$90 Reserves +$9 Checkable
deposits
+$90
Loans +$81
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14-134
Table 1 Creation of Deposits (assuming
10% reserve requirement and a $100
increase in reserves)
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14-135
The Formula for Multiple
Deposit Creation
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14-136
Critique of the Simple Model
• Holding cash stops the process
– Currency has no multiple deposit expansion
• Banks may not use all of their excess
reserves to buy securities or make loans.
• Depositors’ decisions (how much currency to
hold) and bank’s decisions (amount of
excess reserves to hold) also cause the
money supply to change.
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14-137
Summary Table 1 Money Supply
Response
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14-138
Factors that Determine the
Money Supply
• Changes in the nonborrowed monetary base
MBn
– The money supply is positively related to the non
-borrowed monetary base MBn
• Changes in borrowed reserves from the Fed
– The money supply is positively related to the
level of borrowed reserves, BR, from the Fed
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14-139
Factors that Determine the
Money Supply
• Changes in the required reserves ratio
– The money supply is negatively related to the
required reserve ratio.
• Changes in currency holdings
– The money supply is negatively related to
currency holdings.
• Changes in excess reserves
– The money supply is negatively related to the
amount of excess reserves.
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14-140
The Money Multiplier
• Define money as currency plus checkable
deposits: M1
• Link the money supply (M) to the monetary
base (MB) and let m be the money multiplier
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14-141
Deriving the
Money Multiplier I
Assume that the desired holdings of currency C and
excess reserves ER grow proportionally with checkable
deposits D. Then,
c = {C/D} = currency ratio
e = {ER/D} = excess reserves ratio
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14-142
Deriving the
Money Multiplier II
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14-143
Deriving the
Money Multiplier III
• The monetary base MB equals currency (C)
plus reserves (R):
MB = C + R = C + (r x D) + ER
• Equation reveals the amount of the
monetary base needed to support the
existing amounts of checkable deposits,
currency and excess reserves.
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14-144
Deriving the
Money Multiplier IV
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14-145
Intuition Behind the
Money Multiplier
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14-146
Money Supply
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14-147
Determinants of the Money
Supply
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14-148
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Application: The Great Depression
Bank Panics, 1930 - 1933.
• Bank failures (and no deposit insurance)
determined:
– Increase in deposit outflows and holding of
currency (depositors)
– An increase in the amount of excess reserves
(banks)
• For a relatively constant MB, the money
supply decreased due to the fall of the
money multiplier.
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14-150
FIGURE 1 Deposits of Failed
Commercial Banks, 1929–1933
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United
States, 1867–1960 (Princeton, NJ: Princeton University Press, 1963), p. 309.
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14-151
FIGURE 2 Excess Reserves Ratio
and Currency Ratio, 1929–1933
Sources: Federal Reserve Bulletin; Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–
1960 (Princeton, NJ: Princeton University Press, 1963), p. 333.
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14-152
FIGURE 3 M1 and the Monetary
Base, 1929–1933
Source: Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960
(Princeton, NJ: Princeton University Press, 1963), p. 333.
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14-153
货币乘数m1和m2的变化
1999 2000 2001 2002 2003 2004 2005 2006 2007
m1 m2
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14-154
存款准备金率的变动
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Chapter 09
Tools of
Monetary Policy
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14-156
Tools of Monetary Policy
• Open market operations
– Affect the quantity of reserves and the monetary base
• Changes in borrowed reserves
– Affect the monetary base
• Changes in reserve requirements
– Affect the money multiplier
• Federal funds rate: the interest rate on overnight
loans of reserves from one bank to another
– Primary instrument of monetary policy
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14-157
Demand in the Market for
Reserves
• What happens to the quantity of reserves
demanded by banks, holding everything
else constant, as the federal funds rate
changes?
• Excess reserves are insurance against
deposit outflows
– The cost of holding these is the interest rate
that could have been earned minus the interest
rate that is paid on these reserves, ier
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14-158
Demand in the Market for
Reserves
• Since the fall of 2008 the Fed has paid interest on
reserves at a level that is set at a fixed amount
below the federal funds rate target.
• When the federal funds rate is above the rate paid
on excess reserves, ier, as the federal funds rate
decreases, the opportunity cost of holding excess
reserves falls and the quantity of reserves
demanded rises
• Downward sloping demand curve that becomes flat
(infinitely elastic) at ier
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14-159
Supply in the Market for
Reserves
• Two components: non-borrowed and borrowed reserves
• Cost of borrowing from the Fed is the discount rate
• Borrowing from the Fed is a substitute for borrowing from
other banks
• If iff < id, then banks will not borrow from the Fed and
borrowed reserves are zero
• The supply curve will be vertical
• As iff rises above id, banks will borrow more and more at id,
and re-lend at iff
• The supply curve is horizontal (perfectly elastic) at id
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14-160
FIGURE 1 Equilibrium in the
Market for Reserves
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14-161
Affecting the Federal Funds
Rate
• Effects of open an market operation
depends on whether the supply curve
initially intersects the demand curve in its
downward sloped section versus its flat
section.
• An open market purchase causes the
federal funds rate to fall whereas an open
market sale causes the federal funds rate
to rise (when intersection occurs at the
downward sloped section).
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14-162
Affecting the Federal Funds
Rate (cont’d)
• Open market operations have no effect on
the federal funds rate when intersection
occurs at the flat section of the demand
curve.
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14-163
FIGURE 2 Response to an Open
Market Operation
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14-164
Affecting the Federal Funds
Rate (cont’d)
• If the intersection of supply and demand occurs
on the vertical section of the supply curve, a
change in the discount rate will have no effect
on the federal funds rate.
• If the intersection of supply and demand occurs
on the horizontal section of the supply curve, a
change in the discount rate shifts that portion of
the supply curve and the federal funds rate may
either rise or fall depending on the change in
the discount rate
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14-165
FIGURE 3 Response to a Change in
the Discount Rate
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14-166
Affecting the Federal Funds
Rate (cont’d)
• When the Fed raises reserve requirement,
the federal funds rate rises and when the
Fed decreases reserve requirement, the
federal funds rate falls.
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14-167
FIGURE 4 Response to a Change in
Required Reserves
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14-168
Open Market Operations
• Dynamic open market operations
• Defensive open market operations
• Primary dealers
• TRAPS (Trading Room Automated Processing
System)
• Repurchase agreements
• Matched sale-purchase agreements
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14-169
Advantages of Open Market
Operations
• The Fed has complete control over the
volume
• Flexible and precise
• Easily reversed
• Quickly implemented
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14-170
Discount Policy
• Discount window
• Primary credit: standing lending facility
– Lombard facility
• Secondary credit
• Seasonal credit
• Lender of last resort to prevent financial
panics
– Creates moral hazard problem
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14-171
FIGURE 5 How the Federal Reserve’s Operating
Procedures Limit Fluctuations in the Federal
Funds Rate
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14-172
Advantages and Disadvantages
of Discount Policy
• Used to perform role of lender of last resort
– Important during the subprime financial crisis of
2007-2008.
• Cannot be controlled by the Fed; the
decision maker is the bank
• Discount facility is used as a backup facility
to prevent the federal funds rate from rising
too far above the target
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14-173
Reserve Requirements
• Depository Institutions Deregulation and
Monetary Control Act of 1980 sets the
reserve requirement the same for all
depository institutions
• 3% of the first $ million of checkable
deposits; 10% of checkable deposits over
$ million
• The Fed can vary the 10% requirement
between 8% to 14%
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14-174
Disadvantages of Reserve
Requirements
• No longer binding for most banks
• Can cause liquidity problems
• Increases uncertainty for banks
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14-175
Monetary Policy Tools of the
European Central Bank
• Open market operations
– Main refinancing operations
• Weekly reverse transactions
– Longer-term refinancing operations
• Lending to banks
– Marginal lending facility/marginal lending rate
– Deposit facility
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14-176
Monetary Policy Tools of the
European Central Bank (cont’d)
• Reserve Requirements
– 2% of the total amount of checking deposits and other
short-term deposits
– Pays interest on those deposits so cost of complying is low
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Chapter 10
The Conduct of
Monetary Policy:
Strategy and
Tactics
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14-178
The Price Stability Goal
• Low and stable inflation
• Inflation
– Creates uncertainty and difficulty in planning for
the future
– Lowers economic growth
• Nominal anchor to contain inflation
expectations
• Time-inconsistency problem
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14-179
Other Goals of Monetary
Policy
• High employment
• Economic growth
• Stability of financial markets
• Interest-rate stability
• Foreign exchange market stability
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14-180
Should Price Stability be the
Primary Goal?
• In the long run there is no conflict between
the goals
• In the short run it can conflict with the goals
of high employment and interest-rate
stability
• Hierarchical mandate
• Dual mandate
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14-181
Monetary Targeting I
• United States
– Fed began to announce publicly targets for
money supply growth in 1975.
– Paul Volker (1979) focused more in nonborrowed
reserves
– Greenspan announced in July 1993 that the Fed
would not use any monetary aggregates as a
guide for conducting monetary policy
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14-182
Monetary Targeting II
• Japan
– In 1978 the Bank of Japan began to announce
“forecasts” for M2 + CDs
– Bank of Japan’s monetary performance was much
better than the Fed’s during 1978-1987.
– In 1989 the Bank of Japan switched to a tighter
monetary policy and was partially blamed for the
“lost decade”
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14-183
Monetary Targeting III
• Germany
– The Bundesbank focused on “central bank
money” in the early 1970s.
– A monetary targeting regime can restrain
inflation in the longer run, even when targets
are missed.
– The reason of the relative success despite
missing targets relies on clearly stated monetary
policy objectives and central bank engagement
in communication with the public.
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14-184
Monetary Targeting
• Advantages
– Almost immediate signals help fix inflation
expectations and produce less inflation
– Almost immediate accountability
• Disadvantages
– Must be a strong and reliable relationship
between the goal variable and the targeted
monetary aggregate
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14-185
Inflation Targeting I
• Public announcement of medium-term
numerical target for inflation
• Institutional commitment to price stability as
the primary, long-run goal of monetary
policy and a commitment to achieve the
inflation goal
• Information-inclusive approach in which
many variables are used in making decisions
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14-186
Inflation Targeting II
• New Zealand (effective in 1990)
– Inflation was brought down and remained within the
target most of the time.
– Growth has generally been high and unemployment has
come down significantly
• Canada (1991)
– Inflation decreased since then, some costs in term of
unemployment
• United Kingdom (1992)
– Inflation has been close to its target.
– Growth has been strong and unemployment has been
decreasing.
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Inflation Targeting III
• Advantages
– Does not rely on one variable to achieve target
– Easily understood
– Reduces potential of falling in time-
inconsistency trap
– Stresses transparency and accountability
• Disadvantages
– Delayed signaling
– Too much rigidity
– Potential for increased output fluctuations
– Low economic growth during disinflation
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FIGURE 1 Inflation Rates and Inflation Targets
for New Zealand, Canada, and the United
Kingdom, 1980–2008
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Monetary Policy with an
Implicit Nominal Anchor
• There is no explicit nominal anchor in the
form of an overriding concern for the Fed.
• Forward looking behavior and periodic
“preemptive strikes”
• The goal is to prevent inflation from getting
started.
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Monetary Policy with an
Implicit Nominal Anchor II
• Advantages
– Uses many sources of information
– Avoids time-inconsistency problem
• Disadvantages
– Lack of transparency and accountability
– Strong dependence on the preferences, skills, and
trustworthiness of individuals in charge
– Inconsistent with democratic principles
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14-191
Summary Table 1 Advantages and
Disadvantages of Different Monetary Policy
Strategies
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Tactics: Choosing the Policy
Instrument
• Tools
– Open market operation
– Reserve requirements
– Discount rate
• Policy instrument (operating instrument)
– Reserve aggregates
– Interest rates
– May be linked to an intermediate target
• Interest-rate and aggregate targets are
incompatible (must chose one or the other).
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FIGURE 2 Linkages Between Central Bank Tools,
Policy Instruments, Intermediate Targets, and Goals
of Monetary Policy
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FIGURE 3 Result of Targeting on
Nonborrowed Reserves
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FIGURE 4 Result of Targeting on
the Federal Funds Rate
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Criteria for Choosing the
Policy Instrument
• Observability and Measurability
• Controllability
• Predictable effect on Goals
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The Taylor Rule, NAIRU, and
the Phillips Curve
• An inflation gap and an output gap
– Stabilizing real output is an important concern
– Output gap is an indicator of future inflation as shown by
Phillips curve
• NAIRU
– Rate of unemployment at which there is no tendency for
inflation to change
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FIGURE 5 The Taylor Rule for the
Federal Funds Rate, 1970–2008
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Chapter 11
The Demand
for Money
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14-200
Velocity of Money and The
Equation of Exchange
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Quantity Theory
• Velocity fairly constant in short run
• Aggregate output at full-employment level
• Changes in money supply affect only the
price level
• Movement in the price level results solely
from change in the quantity of money
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Quantity Theory of Money
Demand
Divide both sides by V
When the money market is in equilibrium
M = Md
Let
Because k is constant, the level of transactions generated by a fixed level of PY
determines the quantity of Md.
The demand for money is not affected by interest rates
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Quantity Theory of Money
Demand
• Demand for money is determined by:
– The level of transactions generated by the level
of nominal income PY
– The institutions in the economy that affect the
way people conduct transactions and thus
determine velocity and hence k
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FIGURE 1 Change in the Velocity of M1
and M2 from Year to Year, 1915–2008
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Keynes’s Liquidity
Preference Theory
• Why do individuals hold money?
– Transactions motive
– Precautionary motive
– Speculative motive
• Distinguishes between real and nominal
quantities of money
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The Three Motives
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The Three Motives (cont’d)
• Velocity is not constant:
– The procyclical movement of interest rates should
induce procyclical movements in velocity.
– Velocity will change as expectations about future
normal levels of interest rates change
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14-208
Further Developments in the
Keynesian Approach
• Transactions demand
– Baumol - Tobin model
– There is an opportunity cost and benefit
to holding money
– The transaction component of the demand for
money is negatively related to the level of
interest rates
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FIGURE 2 Cash Balances in the
Baumol-Tobin Model
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Precautionary Demand
• Similar to transactions demand
• As interest rates rise, the opportunity cost of
holding precautionary balances rises
• The precautionary demand for money is
negatively related to interest rates
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Speculative Demand
• Implication of no diversification
• Only partial explanations developed further
(Tobin)
– Risk averse people will diversify its portfolio and
hold some money as a store of wealth
– Do not provide a definite answer as to why
people hold money as a store of wealth
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14-212
Friedman’s Modern Quantity
Theory of Money
= demand for real money balances
= measure of wealth (permanent income)
= expected return on money
= expected return on bonds
= expected return on equity (common stocks)
= expected inflation rate
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14-213
Variables in
The Money Demand Function
• Permanent income (average long-run income) is
stable, the demand for money will not fluctuate
much with business cycle movements
• Wealth can be held in bonds, equity and goods;
incentives for holding these are represented by the
expected return on each of these assets relative to
the expected return on money
• The expected return on money is influenced by:
– The services proved by banks on deposits
– The interest payment on money balances
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Differences between Keynes’s
and Friedman’s Model
• Friedman
– Includes alternative assets to money
– Viewed money and goods as substitutes
– The expected return on money is not constant;
however, rb – rm does stay constant as interest
rates rise
– Interest rates have little effect on the demand for
money
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14-215
Differences between Keynes’s
and Friedman’s Model (cont’d)
• Friedman (cont’d)
– The demand for money is stable
velocity is predictable
– Money is the primary determinant of aggregate
spending
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Empirical Evidence
• Interest rates and money demand
– Consistent evidence of the interest sensitivity of the
demand for money
– Little evidence of liquidity trap
• Stability of money demand
– Prior to 1970, evidence strongly supported stability of the
money demand function
– Since 1973, instability of the money demand function has
caused velocity to be harder to predict
• Implications for how monetary policy should
be conducted
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Chapter 12
Transmission
Mechanisms of
Monetary Policy:
The Evidence
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23-218
Structural Model
• Examines whether one variable affects
another by using data to build a model that
explains the channels through which the
variable affects the other
• Transmission mechanism
– The change in the money supply affects interest
rates
– Interest rates affect investment spending
– Investment spending is a component of
aggregate spending (output)
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Reduced-Form
• Examines whether one variable has an effect
on another by looking directly at the
relationship between the two
• Analyzes the effect of changes in money
supply on aggregate output (spending) to
see if there is a high correlation
• Does not describe the specific path
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23-220
Structural Model Advantages
and Disadvantages
• Advantages
– Opportunity to gather more evidence gives more
confidence on the direction of causation
– More accurate predictions
– Understand how institutional changes affect the
links
• Disadvantage
– Only as good as the model it is based on
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23-221
Reduced-Form Advantages
and Disadvantages
• Advantage
– No restrictions imposed on the way monetary
policy affects the economy
• Disadvantage
– Correlation does not necessarily imply causation
• Reverse causation
• Outside driving factor
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23-222
Early Keynesian Evidence
• Monetary policy does not matter at all
• Three pieces of structural model evidence
– Low interest rates during the Great Depression
indicated expansionary monetary policy but had
no effect on the economy
– Empirical studies found no linkage between
movement in nominal interest rates and
investment spending
– Surveys of business people confirmed that
investment in physical capital was not based on
market interest rates
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Objections to Early
Keynesian Evidence
• Friedman and Schwartz publish a monetary history
of the . showing that monetary policy was
actually contractionary during the Great Depression
• Many different interest rates
• During deflation, low nominal interest rates do not
necessarily indicate expansionary policy
• Weak link between nominal interest rates and
investment spending does not rule out a strong link
between real interest rates and investment
spending
• Interest-rate effects are only one of many channels
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23-224
FIGURE 1 Real and Nominal Interest Rates
on Three-Month Treasury Bills, 1931–2008
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FIGURE 3 The Link Between Monetary Policy
and GDP: Monetary Transmission Mechanisms
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Asset Price Effects
• Traditional interest rate effects
Expansionary monetary policy
Emphasis on real interest rate: Expansionary monetary
policy
• Exchange rate effects on net
exports
Expansionary monetary policy
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23-227
Asset Price Effects (cont’d)
• Tobin’s q theory
Expansionary monetary policy
• Wealth effects
Expansionary monetary policy
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23-228
Credit View
• Bank lending channel
Expansionary monetary policy → bank deposits ↑ → bank loans ↑ →
→ I ↑ → Y ↑
• Balance sheet channel
Expansionary monetary policy → Ps ↑ → net worth ↑ →
→ adverse selection ↓, moral hazard ↓→ lending ↑ →
→ I ↑ → Y ↑
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23-229
Credit View (cont’d)
• Cash flow channel
Expansionary monetary policy → i ↓→ cash flow ↑ → adverse selection ↓,
moral hazard ↓→ lending ↑ → I ↑ → Y ↑
• Unanticipated price level channel
Expansionary monetary policy → unanticipated P ↑ → real net worth ↑ →
→ adverse selection ↓, moral hazard ↓→ lending ↑ → I ↑ → Y ↑
• Household liquidity effects
Expansionary monetary policy → Ps ↑ → value of financial assets ↑ →
likelihood of financial distress ↓→ consumer durable and housing
expenditure↑ → Y ↑
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Chapter 13
Money and
Inflation
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Money and Inflation:
Evidence
• Inflation is always and everywhere a
monetary phenomenon
• Whenever a country’s inflation rate is
extremely high for a sustained period of
time, its rate of money supply growth is also
extremely high
• Reduced-form evidence
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24-232
FIGURE 1 Money Supply and Price
Level in the German Hyperinflation
Source: Frank D. Graham, Exchange, Prices and Production in Hyperinflation: Germany, 1920–25 (Princeton, NJ: Princeton
University Press, 1930), pp. 105–106.
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24-233
Views of Inflation
• Money Growth
– High money growth produces high inflation
• Fiscal Policy
– Persistent high inflation cannot be driven by fiscal
policy alone
• Supply Shocks
– Supply-side phenomena cannot be the source of
persistent high inflation
• Conclusion: always a monetary phenomenon
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FIGURE 2 Response to a
Continually Growing Money Supply
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FIGURE 3 Response to a One-Shot Permanent
Increase in Government Expenditure
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FIGURE 4 Response to a Supply
Shock
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Origins of Inflationary
Monetary Policy
• Cost-push inflation
– Cannot occur without monetary authorities
pursuing an accommodating policy
• Demand-pull inflation
• Budget deficits
– Can be the source only if the deficit is persistent
and is financed by creating money rather than by
issuing bonds
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24-238
Origins of Inflationary
Monetary Policy (cont’d)
• Two underlying reasons
– Adherence of policymakers to a high employment
target
– Presence of persistent government budget
deficits
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FIGURE 5 Cost-Push Inflation with an Activist
Policy to Promote High Employment
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FIGURE 6 Demand-Pull Inflation: The Consequence of
Setting Too Low an Unemployment Target
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FIGURE 7 Interest Rates and the
Government Budget Deficit
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FIGURE 8 Inflation and Money
Growth, 1960–2008
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FIGURE 9 Government Debt-to-
GDP Ratio, 1960–2008
Source: Economic Report of the President.
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FIGURE 10 Unemployment and the Natural
Rate of Unemployment, 1960–2008
Sources: Economic Report of the President and Congressional Budget Office.
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24-245
The Discretionary/Nondiscretionary
Policy Debate
• Advocates of discretionary policy regard the
self-correcting mechanism as slow
• Policy lags slow activist policy
– Data lag
– Recognition lag
– Legislative lag
– Implementation lag
– Effectiveness lag
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The Discretionary/Nondiscretionary
Policy Debate (cont’d)
• Advocates of nondiscretionary policy believe
government should not get involved
– Discretionary policy produces volatility in both
the price level and output
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FIGURE 11 The Choice Between Discretionary
and Nondiscretionary Policy
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Expectations and the
Discretionary/Nondiscretionary Debate
• If expectations about policy matter,
discretionary policy with high employment
targets may lead to inflation
• Nondiscretionary policy may prevent
inflation and discourage leftward shifts in
short-run aggregate supply that lead to
excessive unemployment
– Must be credible
• Constant-money-growth-rate rule
