Intermediate Macroeconomics: Monetary Policy

In the Keynesian model we thought of monetary policy as exogenous in the sense that the money supply, Mt, was set exogenously. This is useful for understanding the model but doesn’t really describe how monetary policy works in practice. In the real world, central banks adjust the money supply (and hence interest rates) endogenously in response to changing conditions. In this set of notes we discuss what the objective of the central bank ought to be and how it can adjust the money supply in such a way as to achieve that objective in response to changes in other exogenous variables. We will then briefly talk about monetary policy in practice, mapping our conclusions into the celebrated Taylor rule, which has been taken to be a good standard by which monetary policy should be conducted. We will then discuss the implications of the zero lower bound on nominal interest rates for the Keynesian model.