Money and Monetary Policy

The simple money multiplier explains how money deposited with a financial intermediary can have a greater monetary effect on the economy that the actual value of the deposit. The money multiplier effect is equal to 1 divided by the reserve requirement. The reserve requirement is the proportion of any deposit made into a financial intermediary that the financial is required to retain in reserve. Thus, if the reserve requirement is five-percent, the simple money multiplier equation is mm = 1 / .05, where mm = money multiplier (Mishkin, 2003).  

The money multiplier assumes that the fraction of the original deposit not retained in reserve and the fraction of loaned money that is not retained in reserve is a continuous process at maximum levels permitted by the reserve requirement. This assumption make life theoretically simple for the application of the money multiplier, but it is seldom if ever realized in practice.

Interest rates, as an example, are factors in decisions to borrow money. Thus, in theory higher interest rates dampen the demand for borrowed money while lower interest rates stimulate the demand for borrowed money. If analysis determined the approximate effect of interest rate levels on the demand for borrowed money, this factor could be incorporated into the money multiplier equation as follows: m

. . .
aid to lag the cycle. Whether monetary policy is a leading or a lagging variable, therefore, is relevant to the development and application of monetary policy. 3. Explain the Taylor Rule, and provide a sample equation. Why is inflation targeting important? Provide a numerical example if you can to show how the Taylor Rule will work as the rate if inflation increases? Using data for the United States economy, Taylor (1993) demonstrated that the federal funds interest rate (the interest rate used by the Federal Reserve to implement monetary policy) is a function of the interaction of (a) the nominal interest rate, (b) the rate of price inflation, and (c) the difference between real gross domestic product (GDP) and potential GDP. Taylor (1993) expressed this relationship in the following equation: Rt = (r* + ?*) + 1.5(D4pt – ?*) + 0.5 y ~ t In this equation, Rt = the annualized nominal interest rate (stated in the form of a fraction), r* = the steady-state value of the real interest rate, ?* = the annual inflation target, D4pt = is the annual inflation rate (stated as the fourth difference of the log price level), and y ~ t = the difference between real GDP and potential GDP (stated in log values). In the original Taylor (1993
. . .

Some common words found in the essay are:
, Cooley Quadrini, Taylor Rule, GDP Taylor, Friedman Schwartz, Explain Friedman's, Federal Reserve, Accessed Internet, Princeton NJ, monetary policy, Education Taylor, money multiplier, inflation rate, taylor rule, money supply, rate inflation, nominal rate, variables relationship move, variable relationship, variable relationships, output variable, value changes variables, changes variables relationship, changes values variables, relationship move direction,
Approximate Word count = 1406
Approximate Pages = 6 (250 words per page)

More Essays on Money and Monetary Policy