Monetary Policy, Interest Rates, and Aggregate Expenditure



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Ecn. 120

Todd Easton



March 2011
Monetary Policy, Interest Rates, and Aggregate Expenditure
Last class we looked at the responsibilities of the Fed. For our purposes, the most important responsibility of the Fed is controlling the supply of money. Mostly, as we saw in class, the Fed exercises its control over the money supply through open market operations. In particular, we saw that the Fed buys Treasury bonds when it wishes to make the money supply bigger. It sells Treasury bonds when it wishes to make the money supply smaller. 1
This control over the money supply is not important for its own sake. It matters because the changes in the money supply the Fed brings about affect the level of interest rates in our economy. The level of interest rates, in turn, affects the level of total spending (aggregate expenditures). This handout explains how open market operations affect interest rates and how the Fed decides what level of interest rates it desires. It also explains how the Fed attains its interest rate target and how changes in interest rates affect the level of spending in the economy.


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