Monetary Policy and Financial Markets

Economics 321

Professor Aschauer

Winter 2000

This course is a survey of modern financial markets and the role of monetary policy in influencing asset returns and the performance of the aggregate economy. Topics which are covered in the course include:

• the accumulation of wealth
• interest rate determination
• theories of the term structure
• theories of money demand
• the money supply process
• the Federal Reserve System
• the conduct of monetary policy
• rational expectations
• money & international finance.

We will begin the course with an overview of financial markets and the role of financial intermediaries. We will focus on the importance of money--an asset which performs as a medium of exchange--to the economy. After considering the supply of and demand for money, we will turn to the influence of the Federal Reserve on variables such as:

• interest rates
• employment & economic growth
• inflation
• exchange rates.

The recommended textbook for the course is Money, the Financial System, and the Economy [MFSE] by R. Glenn Hubbard, Third Edition (Addison Wesley, 2000). I will make my lecture notes available as the term progresses.

Outline & Readings

I. Functions of Financial Markets

[Read: Class Notes 1-68; MFSE Chapters 1-7]

A. Overview of Financial Markets

B. Intertemporal decisions and interest rates

C. Asset pricing & portfolio decisions

II. The Money Supply Process & the Federal Reserve System

[Read: Class Notes 69-95; MFSE Chapters 12, 17-21]

A. Commercial banks & credit creation

B. The money supply process

C. The Federal Reserve System & the conduct of monetary policy [MFSE 19-20]

III. Money Demand

[Read: Class Notes 96-115; MFSE Chapter 23]

A. Theory

B. Empirical evidence

IV. Operating Procedures, Intermediate Targets, and Ultimate Targets of Monetary Policy

[Read: Class Notes 116-128; MFSE Chapter 21]

A. Operating Procedures

B. Monetary Transmission Channels

V. Monetary Policy and Financial Markets

[Read: Class Notes 129-135]

VI. Monetary Policy and Economic Activity

[Read: Class Notes 136-155; MFSE Chapters 24-28]

A. Monetary Policy in the Long Run

B. Monetary Policy in the Short run

IV. Monetary Policy in the International Economy

[Read: Class Notes 156-176; MFSE Chapters 8, 22]

A. Exchange Rates

B. Monetary Policy, Exchange Rates, and Economic Activity

Miscellaneous

Examinations & exercises: There will be one mid-term examination and a comprehensive final examination. Exercises will be assigned periodically.

Term project: A term project will be required in this course. This project will involve student preparation of presentations on the state of the economy in the format of a "mock" Federal Open Market Committee (FOMC) meeting. For instance, a team of students will be given the task of reporting on recent movements in inflation, forecasting future inflation trends, and offering a policy recommendation of tighter, looser, or unchanged monetary policy. This mock FOMC meeting will be held during the last weeks of the course (preferably around the time of an actual FOMC meeting).

Course Grade: The course grade will be a weighted average of examination grades, of the term project grade, of grades on exercises, and on class participation. The following weights will be used in the computation of the course grade:

20% on midterm exam

30% on final exam

20% on term project

15% on exercises

15% on class participation

Office: Pettingill 270

Phone: 786-6099

Office Hours: M/W 1-2:30.