Chapter 14

Monetary Policy and the Short-Run Economy

IN THIS CHAPTER

Understanding how monetary policy works

Using monetary policy to counteract demand shocks

Weighing the pros and cons of countercyclical monetary policy

Stimulating the economy with quantitative easing

Imagine that you make a withdrawal of $500 in the form of five $100 bills from your bank account one evening in anticipation of some heavy cash expenditures the next day. Before retiring for the evening, you put your wallet on the bedside table. Then you turn off the light, roll over, and go to sleep. The next morning you awake, shower, shave, dress, and grab a bit of breakfast. Just before leaving the house you look in your wallet and discover a shocking development. The five $100 bills you had the night before have suddenly changed to $1 bills. You rush to the bank to find that the same is true of your checking and savings account. In fact, all your money assets are now worth one one-hundredth of what they were.

Sound outrageous? Well, it’s pretty much what happened to everyone in France between 1958 and 1960. As President Charles de Gaulle ushered in the new Fifth Republic he also introduced a new French franc, and it took 100 old francs to buy one new one. Measured just in francs — with no distinction made between new ones and old ones — this lopping off of a couple of zeros would reflect a major change in the French money supply. In turn, that change would affect real GDP, the price level, and other macro ...

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