Notes for a Talk on Teaching the Very Basics of Monetary Policy...

Notes on teaching the very basics of monetary policy

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Teaching Monetary Policy

Bradford DeLong

November 3, 2006; Amelia Island, FL

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The Federal Reserve Acts:

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We Would Like Our Students to Be Able to Read the Wall Street Journal:

Like http://online.wsj.com/article/SB116179074182303451-search.html?KEYWORDS=bernanke&COLLECTION=wsjie/6month

Greg Ip:

Mr. Bernanke has faced shifting challenges since taking office. Core inflation has risen to 2.9% from 2.1%, the highest level in a decade…. That led the Fed to raise rates at its first three meetings under Mr. Bernanke…. [E]conomic growth, under the weight of falling home and automobile sales, began to slow, to an estimated annual rate of about 2% in the third quarter. That would be the second-lowest level since 2003. In recent weeks, though, both inflation and growth worries have eased. Energy prices have plunged, and the Fed expects the indirect impact of that drop to pull down core inflation in the coming year or so. Yesterday's Fed statement dropped a reference from the previous month to energy and commodity prices as a source of inflation pressure. There is little sign the economy outside housing and cars has slowed much...

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What We Want to Teach Them So They Can Do So?

Federal Reserve objectives:

• Effective price stability *Given that, unemployment as low as possible--at the natural rate

Federal Reserve tools:

• Controls short-term, safe, nominal interest rates

Economic environment:

• Term structure: what matters most are long-term, real, risky interest rates
• Which affect investment spending (primarily construction) and exports
  • Multiplier *Long and variable lags

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How Do We Teach Them?

• Keynesian cross?
  • Is it worth spending time on the multiplier?
• AS-AD?
  • What gives the AD curve its downward slope?
• Quantity Theory of Money?
  • How to get from MV=PY to the Fed announcements?
• IS-LM?
  • Too complicated for Principles--which means not retained well in intermediate…

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And How Do We Get Them to Retain Enough to Be Economically Literate?

To be able, for example, to talk coherently about U.S.-China economic relations:

• Trade side:
  • Gains from trade…
  • Long-term political benefits from a richer and more democratic China…
  • Long-term political costs…
  • U.S. manufacturing employment…
  • Other U.S. distributional issues
• Macro side:
  • Crowding in via PBoC purchases of U.S. Treasuries and other assets…
  • Cost of repaying foreign debt…
  • Possibility of foreign-exchange crisis…
• Need to connect the syllabus up to the issues: How?

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For McGraw-Hill Amelia Island, FL conference, Nov. 2-4, 2006