Monetary Theory and Policy (Eco 403)

Monetary Theory and Policy (Eco 403)




Course Description

Monetary Economics is concerned with the effects of monetary institutions (such as the Federal Reserve Bank) and policy actions on economic variables (such as inflation and interest rates) that are of importance to individuals and firms. Monetary Policy is considered by many to be of critical importance to the economy. Indeed, Ben Bernanke, the chair of the Federal Reserve Bank, is often called the second most powerful man in the United States. The Federal Reserve is playing a critical role in the government's respose to the credit crises, recession, and recovery.

The class will consist of three parts. In the first part, we will study money and related variables such as inflation and interest rates. This includes study of the banking system and various institutions such as the Federal Reserve. The second part of the course examines monetary policy. Once we understand the relationships between money, interest rates, and inflation, we can ask what the optimal interest rate policy is, and how to implement it. The third part of the course examines interesting monetary episodes in the US and across the world.

General Information

Professor: Associate Professor Dr. David L. Kelly (Dave).

Course Meetings: Mondays and Wednesdays from 3:35 to 4:50 pm in room SB 308.

Office: Room 521B, Jenkins School of Business.

Office hours: Tuesdays at 2-3 pm (Dave is almost always around during business hours, but try to come during office hours if you can).

Contacts: Dave can be contacted via phone (8x3725) or email (

Web Site: Dave has established a website ( for this course. At this site, you can download or view course material (homeworks, etc.), as well as a continuously updated syllabus.

Final Exam: Monday, May 7 from 2 pm to 4:30 pm (Section H).


This course requires Eco 212 (Principles of Macroeconomics).


The class follows the lecture notes, which are available on the website. However, some parts follow the following textbook, which is optional.

Dean Croushore, Money and Banking: A Policy Oriented Approach Houghton Mifflin Company, Boston, MA, 2007.

A few sections follow this book (again optional):

Bennett T. McCallum, Monetary Economics: Theory and Policy. Macmillan Publishing, NY, 1989.


  • 3 Homeworks (Feburary 8, March 21, and April 18) 25%
  • First Challenge (Quiz): Wednesday February 22, 25%
  • Second Challenge (Quiz): Wednesday April 4, 25%
  • Final Challenge (Quiz): Monday May 7, 25%
  • You can now access your grades on line HERE!

    Additional Notes

    Some Macro Links and Career Information

    Course Outline

    DC is the Dean Croushore book and BM is the the Bennett McCallum book.

    1. Introduction (BM:1, January 18 - February 1).
      1. Facts about the Monetary Economy (DC:1).
      2. Money (BM:2, DC:3,8,15, DC:461-488)
        1. Functions of Money (DC:3)
        2. Measures of Money
        3. Fiat vs. Commodity Money
        4. The Banking System (DC:8)
        5. The Federal Reserve (DC:15)
      3. Inflation
      4. Interest Rates (DC:p110-118,150-159)
    3. The Money Market (February 8-22)
      1. Money Supply (BM:4.1-4.4, DC:p461-488)
      2. Money Demand (BM:3.1)
        1. Baumol-Tobin Model (BM:3.6, DC:307-315)
        2. Velocity (BM:3.5)
        3. Cagan Model (BM:7.1)
    4. The Inflation Tax (article, February 27 - February 29)
      1. Seniorage
      2. Welfare costs of the inflation tax
      3. Budget Deficits and Inflation
      4. Laffer Curve of Inflation Tax
    5. Classical and Keynesian Models (BM:5, DC:12, March 5-21)
      1. Aggregate Demand (BM:5.1-5.4)
      2. Classical Aggregate Supply (BM:5.5)
      3. Keynesian Aggregate Supply (BM:5.7, 5.8)
      4. Neutrality and Policy in the Classical Model (BM:5.6)
      5. HOMEWORK 2, DUE MARCH 21
      6. Policy and policy effectiveness in the Keynesian Model (BM:5.8)
      7. Phillips Curve (March 26-March 28)
        1. Classical and Keynesian (BM:9.2, DC:512-516)
        2. Lucas Monetary Misperceptions (BM:9.4, DC:516-520)
    6. Monetary Policy Implementation (April 2-18)
      1. Policy Rules vs. Discretion (BM:12,11.3, DC:p494-512, DC:18)
      2. Targeting
        1. Interest Rate Targeting (BM:4.4)
        2. Money Supply Targeting (BM:4.3)
        3. Exchange Rate Targeting (BM:14.5-14.7)
        4. Inflation Rate targeting (including asset price inflation, articles)
      3. HOMEWORK 3, DUE APRIL 18
      4. Commodity Standards (BM:13)
    7. Interesting Monetary Episodes (April 23-25)
      1. Recent episodes: Federal Reserve and the credit crises (articles)


    Class Handouts

    Note: all handouts may be downloaded as Adobe Acrobat pdf files. If your computer cannot read acrobat files, download the reader for free HERE .

    Homework 1, Due Wednesday February 8.

    Homework 1, Solutions.

    Review, First Quiz.

    Review solutions, First Quiz.

    First Quiz.

    First Quiz, Solutions.

    Homework 2, Due March 21.

    Homework 2, Solutions.

    Review, Second Quiz.

    Second Quiz.

    Second Quiz, Solutions.

    Homework 3, Due April 18.

    Homework 3, solutions.

    Final Review

    Notes, graphs, tables, etc.

    Below are some notes for the class. I will add notes periodically throughout the semester. You will see that these notes, while helpful, are in an outline format and do not substitute for the notes taken in class.

    Notes: Introduction (Section I)

    Notes: Money Market and Inflation Tax (Section II, III)

    Notes: Classical Model (Section IV)

    Notes: Phillips Curve (Section V)

    Notes: Monetary Policy Implementation (Section VI)

    Velocity in the United States

    Velocity in some high inflation economies

    Liquidity Trap

    intro graph

    Up to Dave Kelly's homepage

    Macroeconomics Links

    Careers in Economics