Course Outline: EE 432 Monetary Theory and Policy

Semester: 2/2007 (January 9th – April 25th , 2007)
Instructor: Dr. Phurichai Rungcharoenkitkul
Time: Wednesdays and Fridays, 8.00-9.30 am
Room: TBA, Faculty of Economics

Prerequisite: EE 312 Macroeconomics Theory

Course Objectives:
This course aims to provide a fundamental understanding of the most basic questions in monetary economics: What is the role of money? What causes inflation? How does monetary policy affect output? Insights into these questions underline some of the most important developments in macroeconomics in the 20th century. We will address them theoretically in the first part of the course. The second part then turns to the policy making aspect. We will see how knowledge from the first part can help us conduct the monetary policy in a more scientific and ‘optimal’ way, at least conceptually. We will also discuss issues related to credit and banking, as well as other non-resolved current issues in monetary economics that have been of interest to academics and policy makers in recent years.
EE432 is offered as an upper level theory course. As such, much of the course will be analytical in nature. The treatment of these topics will be at an advanced and sophisticated level, set in the context of fully specified monetary models with micro-foundations. Focus will be on depth rather than scope, so we would spend time learning important issues in details rather than trying to be comprehensive in coverage. Students are expected to read first-rate journal articles in order to sharpen their analytical adeptness, and to familiarize themselves with the theoretical way of thinking about economics. Do not give up if you do not understand everything after the first reading; it is very common. Consult other textbooks or survey articles which offer alternative treatments. Discuss the issues with your friends, and if all else fails, feel free to consult me.
Class attendance and participation are very important because each week's learning depends on accurate understanding of what had preceded it. I encourage you to ask questions in class - especially if you are confused or unclear about what we are doing and/or why we are doing it. Please also feel free to comment on any of the material we cover and even to ask questions about economic items of interest that aren't directly related to the course. If time permits, I'm always happy to take a detour.

Textbooks:
There is no single set textbook, as the course will be based on various sources including selected chapters from textbooks and journal articles. Good undergraduate-level expositions on many topics to be covered can be found in:
· Modeling Monetary Economies by Bruce Champ and Scott Freeman, Cambridge University Press, 2001, 2nd edition. [CF]
As we venture into the realm of more advanced topics, you may find certain graduate-level textbooks instructive as sources of reference. Amongst those worth looking at are:
· Monetary Theory and Policy, 2nd Edition by Carl Walsh, MIT Press, 2003. [Wa]
· Interest and Prices: Foundations of a Theory of Monetary Policy by Michael Woodford, Princeton University Press, 2003. [Wo]
· Advanced Macroeconomics, 2nd Edition by David Romer, McGraw-Hill, 2000. [R]
· Lectures on Macroeconomics by Olivier J. Blanchard, and Stanley Fischer, MIT Press, 1989. [BF]

Course Requirements:
There will be 4-5 problem sets, 1 midterm, and a final.
The breakdown of the points is as follows:
- Problem sets: 10%
- Midterm: 30% (1.30 hours, towards end of February. Exact date TBA)
- Final: 60% (3 hours, towards mid-May. Exact date TBA)

Homework:
There will be 4-5 problem sets handed out during the course. Your answers will be due at the beginning of class one week after a problem set is assigned. Late problem sets will not be accepted. You are allowed, even encouraged to work together on all your assignments. However you are required to write down your assignments on your own. It is a good idea to attempt the problems on your own before meeting with a group. These problem sets are excellent preparation for exams.

Exams:
We will have one midterm and a final exam. The exams will be a mixture of essays and mathematical problems, and cover materials presented in class or used in problem sets and handouts distributed in class. All exams are closed-book.

Tentative Outline
Part 1: Monetary Theory

Topic 1: Foundations of Monetary Theory
· Money as the store of value
· Money as the medium of exchange
· Demand for money
Readings:
Baumol, W.J. (1952), “The Transactions Demand for Cash: An Inventory Theoretic Approach,” Quarterly Journal of Economics, Vol.66, November, 545-556.
Kiyotaki, N. and R. Wright (1989), “On Money as a Medium of Exchange,” Journal of Political Economy, Vol. 97, August, 927-954.
Kiyotaki, N. and R. Wright (1993), “A Search-Theoretic Approach to Monetary Economics,” American Economic Review, Vol. 83, March, 63-77.

Topic 2: New Classical Macroeconomics
· Does money affect output? An empirical review
· Money neutrality and flexible prices
· Lucas model of money illusion
Readings:
Friedman, M. (1977), “Nobel Lecture: Inflation and Unemployment,” Journal of Political Economy, Vol.85, June, 451-472.
Lucas, R.E., Jr. (1972), “Expectations and the Neutrality of Money,” Journal of Economic Theory, Vol.4, April, 103-124.
Lucas, R.E., Jr. (1973), “Some International Evidence on Output-Inflation Tradeoffs,” American Economic Review, Vol.63, June, 326-334.
Lucas, R.E., Jr. (1996), “Nobel Lecture: Monetary Neutrality,” Journal of Political Economy,” Vol.104, August, 661-682.
Sargent, T. and N. Wallace (1975), “’Rational Expectations,’ the Optimal Monetary Instrument, and the Optimal Money Supply Rule,” Journal of Political Economy,” Vol.83, April, 241-254.

Topic 3: New Keynesian Macroeconomics
· Imperfect competition and menu cost
· Nominal vs. real rigidities
· Staggered price setting
Readings:
Ball, L, N.G. Mankiw, D. Romer, G.A. Akerlof, A. Rose, J. Yellen, and C. A. Sims (1988), “The New Keynesian Economics and the Output-Inflation Tradeoff,” Brookings Papers on Economic Activity, Vol.1988, May, 1-82.
Ball, L, and D. Romer (1990), “Real Rigidities and the Non-Neutrality of Money,” Review of Economic Studies, Vol.57, April, 183-204.
Mankiw, N.G. (1985), “Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly,” Quarterly Journal of Economics, Vol.100, May, 529-539.+
Romer, D. (1993), “The New Keynesian Synthesis,” Journal of Economic Perspectives, Vol.7, Winter, 5-22.

Topic 4: Credit and Banking
· Bank runs
· Credit crunch
· Agency costs
Readings:
Bernanke, B.S., and A.S. Blinder (1988), “Credit, Money and Aggregate Demand,” American Economic Review, Papers and Proceedings, Vol.78, May, 435-439.
Bernanke, B.S., and M. Gertler (1989), “Agency Costs, Net Worth, and Business Fluctuations,” American Economic Review, Vol.79, March, 14-31.
Bernanke, B.S., and C.S. Lown (1991), “The Credit Crunch,” Brookings Papers on Economic Activity, Vol.1991, 205-247.
Diamond, D.W., and P.H. Dybvig (1983), “Bank Runs, Deposit Insurance, and Liquidity,” Journal Political Economy, Vol.91, June, 401-419.

Part 2: Monetary Policy

Topic 5: Time Inconsistency
· Inflation bias of discretionary policy
· Solutions
Readings:
Barro, R.J., and D.B. Gordon (1983), “Rules, Discretion, and Reputation in a Model of Monetary Policy,” Journal Monetary Economics, Vol.12, June, 101-121.
Kydland, F.E., and E.C. Prescott (1977), “Rules Rather Than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy, Vol.85, June, 473-491.

Topic 6: The Mechanics of Monetary Policy
· Monetary Operation
· Monetary Transmission Mechanism
Readings:
Bernanke, B.S., and M. Gertler (1995), “Inside the Black Box: The Credit Channel of Monetary Policy Transmission,” Journal Economic Perspectives, Vol.9, Autumn, 27-48.
Borio, C.E.V. (1997), “The Implementation of Monetary Policy in Industrial Countries: A Survey,” BIS Economic Papers, No.47.
Disyatat, P. (2002), “Monetary Policy and the Transmission Mechanism in Thailand,” BOT Research Symposium 2002.
Poole, W. (1970), “The Optimal Choice of Policy Instruments in a Simple Stochastic Macro Model,” Quarterly Journal of Economics, Vol.84, May, 197-216.


Topic 7: The Science of Monetary Policy
· Monetary policy framework
· Optimal monetary policy
· Inflation targeting
Readings:
Bernanke, B.S. and F. Mishkin (1997), “Inflation Targeting: A New Framework for Monetary Policy?” Journal of Economic Perspectives, Vol. 11, Spring, 97-116.
Blinder, A.S. (1997). “What Central Bankers Can Learn from Academics—and Vice-Versa,” Journal of Economic Perspectives, Vol.11, 3–19.
Clarida, R.J., J. Gali, and M. Gertler (1999), “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature, Vol.37, December, 1661-1707.
Svensson, Lars E.O. (1997), “Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets,” European Economic Review, Vol.41, 1111-1146.
Svensson, Lars E.O. (1999), “Inflation Targeting as a Monetary Policy Rule Inflation,” Journal of Monetary Economics, Vol.43, 607-654.
Woodford, M. (2004), “Inflation Targeting and Optimal Monetary Policy,” Federal Reserve Bank of St. Louis Review, 15-41.

Topic 8: Current Issues in Monetary Policy
· Liquidity trap
· Great moderation
· Roles of asset prices
· Fiscal-Monetary-Exchange rate policies mix
Readings:
Bernanke, B.S. and M. Gertler (1999), “Monetary Policy and Asset Price Volatility,” Federal Reserve Bank of Kansas City, Economic Review, Fourth Quarter, 17-51.
Krugman, P. (1998), “Japan’s Trap,” mimeo.

Have a good semester!