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MODULE 32

Money, Output, and Prices in the Long Run

In this Module, you will learn to:

In the previous module we discussed how expansionary and contractionary monetary policy can be used to stabilize the economy. The Federal Reserve can use its monetary policy tools to change the money supply and cause the equilibrium interest rate in the money market to increase or decrease. But what if a central bank pursues a monetary policy that is not appropriate? That is, what if a central bank pursues expansionary policy during an expansion or contractionary policy during a recession? In this module we consider how a counterproductive action by a central bank can actually destabilize the economy in the short run. We also introduce the long-run effects of monetary policy. As we learned in the last section, the money market (where monetary policy has its effect on the money supply) determines the interest rate only in the short run. In the long run, the interest rate is determined in the market for loanable funds. Here we look at long-run adjustments and consider the long-run effects of monetary policy.