MEC 510: Monetary Economics

Course Objective

This course introduces and examines a number of topics in monetary economics.

The objective of this course is to help students in developing understanding why
money exists and how it is created, what the roles of banks in the creation of money
are along with their roles in monetary transmission mechanism in relation to the
money supply and interest rates and their impacts on real economy. Further
emphases will be on developing macroeconomic models to evaluate monetary
policies including open economy models, exchange rate regimes and determination
of different nominal anchors such as price levels and exchange rates.

Course Outline

1. A review of basic macroeconomic tools: Money market equilibrium - Interest

rate as the equilibrating factor, The LM curve; Goods market equilibrium - The IS
curve; The AD and AS curves, Effects of monetary and fiscal policy
2. Money and Monetary Economy: Emergence and evolution of money;
Functions of money; Commodity and fiat money; Inside and outside money;
Narrow money (M1) and Broad money (M2)
3. Deposit Money Bank system: Functions of deposit banks; Mobilisation and
distribution of loanable funds; Balance sheet - Assets and liabilities; Risks and
profit, capital adequacy, liquidity; Bank regulations
4. Central bank: Origin and functions of central banking; Balance sheet - Assets
and liabilities; Bank reserves and monetary base
5. Money supply process: Fractional reserve banking; Multiple deposit creation;
Determinants of money multiplier; Zero statutory reserve ratio banking
6. Demand for money: Keynes contribution; Transactions demand; Speculative
demand; Quantity theory; Liquidity trap and zero lower bound of interest rates
7. Money and Inflation: Causes of inflation; Phillips curves in the short and long
run; Seigniorage and inflation tax; Costs of inflation, Nominal anchors - money
supply, inflation rate and exchange rates
8. Expectations and output: Rational expectations and Lucas supply curve;
Neutrality of money; Policy ineffectiveness; Time inconsistency, Rules vs.
discretion; Inflation experience of Bangladesh
9. Monetary policy: Goals and tools of monetary policy; Proximate, intermediate
and ultimate targets; Independences in goals vs. instrument; Conducting
monetary policy - open market operations, reserve ratios, discount rates,
Quantitative easing, others; Inflation targeting and Taylors rule, monetary
condition index; Uncertainty and the choice of instruments
10.Transmission mechanisms of monetary policy: Interest rate and aggregate
demand (Cost of capital effect, Wealth effect, Income effect, Intertemporal
substitution effect, Exchange rate effect); Interest rate channel; Asset price
channel; Credit channel
11.Exchange Rate Regime: Fixed, Flexible and Managed Float; Role of Central
Bank in Fixed and Managed Exchange Rate Regimes; Reserve Currencies;
Exchange Market Intervention and the Money Supply; Sterilized and Unsterilized
Intervention; Exchange market pressure; Capital Flows
12.Exchange Rate and Price Level: The law of one price, purchasing power
parity, empirics.

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13.Effectiveness of Monetary Policy and Exchange Rate Regimes: Trilemma;
Exchange rate stability, Capital Flows and monetary policy
14.Monetary policy and asset prices: Financial crisis; Formation of bubbles;
Monetary policy response
15.Monetary Policy of Bangladesh: The financial structure; Objectives and tools
of monetary policy; Monetary programming

References

R. Barro and G Gordon (1983). Rules, Discretion and Reputation in a Model of

Monetary Policy, Journal of Monetary Economics 12 (1983) 101-121. North-
Holland
*B. Bernanke, T. Laurbach, F. Mishkin and A. Posen (2001). Inflation
Targeting, Princeton University Press. Ch. 2.
*M. Friedman (1968). The Role of Monetary Policy, American Economic Review,
Vol. LVIII, No. 1 (March), pp. 1-17.
*A. Greenspan (2010). The Crisis, Brookings Papers on Economic Activity,
(Spring), pp. 201-261
M. Krueger, M. Obstfeld. And M. Melitz, International Economics: Theory and
Policy, Addison-Wesley.
F. Kydland and E. Prescott (1977). Rules Rather than Discretion: The
Inconsistency of Optimal Plans, The Journal of Political Economy, Vol. 85, No. 3.
(June), pp. 473-492.
*M. Lewis and P. Mizen (2000). Monetary Economics, Oxford University Press.
*R. Lucas Jr (1973). Some International Evidence on Output-Inflation Tradeoffs,
American Economic Review, VOL. 63 NO. 3 (June), pp. 326-334.
*F. Mishkin (2012). The Economics of Money, Banking and Financial Markets,
Addison-Wesley series.
R. Mundell (1962). The Appropriate Use of Monetary and Fiscal Policy for Internal
and External Stability, Staff Papers International Monetary Fund, Vol. 9, No. 1
(March), pp. 70-79.
A. Phillips (1958). The Relation between Unemployment and the Rate of Change
of Money Wage Rates in the United Kingdom, 1861-1957, Economica, Vol. 25, No.
100 (November), pp.283-299.
W. Poole (1999). Monetary Policy Rules? Review, Federal Reserve Bank of St.
Louis, March-April .
M. Taslim and A. Chowdhury (1995). Intermediate Macroeconomics, Prentice
Hall (for a quick revision of relevant material).
*M. Taslim (2003). Monetary Policy and Monetary Programming in Bangladesh,
Bangladesh Development Studies, Vol. XXVII, December, pp. 81-99.
*J. Taylor (2008). The Financial Crisis and the Policy Responses: An Empirical
Analysis of What Went Wrong, Bank of Canada, A festschrift in honour of David
Dodge, (November).
C. Walsh (2010). Monetary Theory and Policy, MIT Press.

*Compulsory readings. Other references will be given in the class.