Unit#5: Monetary Policy and Financial Sector

  • Unit #5: Monetary Policy and the Financial Sector

    To understand how monetary policy works, students must understand the definitions of both the money supply and money demand and the factors that affect each of them. Here the course introduces students to the definition of money and other financial assets, such as bonds and stocks, the time value of money, measures of the money supply, fractional reserve banking, and the Federal Reserve System. In presenting the money supply, it is important to introduce the process of multiple-deposit expansion and money creation using T-accounts, and the use of the money multiplier. In learning about monetary policy, it is important to define money demand and examine its determinants. Having completed the study of money supply and money demand, the course should proceed to investigate how equilibrium in the money market determines the equilibrium nominal interest rate.


    Using the investment demand curve, the students should establish the link between changes in the real interest rate and changes in aggregate demand and understand how changes in aggregate demand affect real output and price level. Students should have an understanding of financial markets and the working of the loanable funds market in determining the real interest rate. It is also important that students develop a clear understanding of the differences between the money market and the loanable funds market. 


    Having an understanding of the financial markets, students should identify and examine the tools of central bank policy and their impact on the money supply and interest rate . Students should understand the distinction between nominal and real interest rates . Students should also be introduced to the quantity theory of money, and examine and understand the effect of monetary policy on real output growth and inflation.