2. Alternative Sequencing

Instructors have several options for presenting money market equilibrium. The most straightforward presentation would rely on Section 4.2 for the cash economy and progress to Section 4.3 if banks and checkable deposits are introduced. Section 4.3 equates demand and supply for central bank money. Alternatively, to emphasize the federal funds market, instructors could present equilibrium with banks in terms of the supply and demand for reserves; to emphasize the money multiplier, instructors could present equilibrium with banks in terms of the supply and demand for money. These latter approaches are presented in Section 4.4. Note that Section 4.4 is entirely optional.

The interest rate was not introduced in the discussion of the goods market in Chapter 3. Thus, at this point in the text, the determination of the interest rate seems to stand apart from the determination of real output. As discussed in Part V of Chapter 3 of the Instructor’s Manual, an alternative is to introduce the dependence of investment on the interest rate in Chapter 3 and to assume a fixed interest rate.

Another option is to introduce some of the material in Chapter 25, devoted to monetary policy, in the discussion of the current chapter. Some of the basic facts about the structure of the Federal Reserve may be helpful to orient students and to help facilitate discussion of current Fed policy.

3. Enlivening the Lecture

Casual empiricism suggests that undergraduates have more immediate interest in material related to financial markets than in almost any other topic. A discussion relating the material of the chapter to current Federal Reserve policy (perhaps with a few words about the stock market’s response to Fed policy) would probably be interesting to students.

Another suggestion is to look at the interest rate section of the financial pages of a major newspaper during the lecture. Besides making the financial pages a bit more accessible to students, this strategy might also provide an opportunity to discuss the inverse relationship between prices and interest rates.

VI. Extensions

1. The Balance Sheet Constraint

To clarify the relationship between bond market and money market equilibrium, it may be useful to be more explicit about the implications of the balance sheet constraint. The constraint implies

M^d+B^d=Financial Wealth=M+B,

or

(M^d - M)=(B – B^d).

In other words, the excess demand for money must equal the excess supply of bonds. When one market clears, the other must clear as well.

2. The Money Demand Function

This chapter assumes a money demand function of the form M^d=$YL(i)=PYL(i). A more general alternative would be M^d=L($Y,i). The functional form assumed in the chapter allows for an easy conversion to real money demand by dividing through by the price level. Introducing the more general form requires explaining to students that money demand should be homogeneous of degree one in P. On the other hand, this exercise does make clear what is assumed.

VII. Observations

1. The Definition of Money Demand

Money demand refers to a portfolio decision, the amount of fixed wealth that the nonbank public desires to hold in money as opposed to bonds. Money demand does not refer to the demand for income or wealth.