London School of Economics and Political Science (LSE)

Modules

115
Monetary Economics

Prerequisite – 65 Macroeconomics

Exclusions: this unit has replaced 14 Monetary economics and may not be taken if a student is taking or has passed 14 Monetary economics.

This unit is split into three sections. Each one builds on the ideas
and theories of the previous section, working up from
microeconomic explanations of why people hold money, to
models of international monetary economies.

Section 1: Introduction to money and monetary economics
The nature of money
- What constitutes money. Why people hold money;
introduction to cash in advance (CIA) and money in the
utility (MIU) functions.
Money demand and supply
- Microeconomic determinants of the demand for money and
macroeconomic money demand functions. Financial
intermediaries, banks and money creation.
The Classical school, neutrality of money and the quantity
theory
- The Classical dichotomy, Walras’ and Say’s laws,
introduction to money in a general equilibrium setting.

Section 2: Monetary policy
The Classical model, flexible price economies and monetary
policy
- Rational expectations, representative agents and real
business cycle theory. MIU, CIA, Lucas supply functions
and the effects of monetary policy.
The Keynesian approach to monetary policy – nominal rigidities
- Multi-period pricing and the persistence of monetary policy
shocks.
Policy ineffectiveness and Central Bank independence
- The Lucas critique. Monetary policy rules: interest rate
targeting and money targeting. Issues in monetary policy:
rules versus discretion.
The welfare effects of inflation and monetary policy
- Neutrality and superneutrality of money, welfare costs and
the Friedman rule, seigniorage and the inflation tax.
Term structure of interest rates
- Explanation of the yield curve: expectations hypothesis and
the segmentation hypothesis.

Section 3: International monetary arrangements
Money, interest rates and exchange rates
- Introduction to income accounting in an open economy,
uncovered and covered interest rate parity.
Prices and the exchange rate
- Law of one price, absolute and relative purchasing power
parity.
Monetary policy in an open economy setting
- Monetary theory of the exchange rate, monetary policy and
exchange rate overshooting.
Exchange rate regimes
- Gold standard, Bretton Woods, floating exchange rates,
optimal currency area theory and issues in the euro.