MONETARY ECONOMICS 1

Monetary Economics
Lecturer: Vladimir N. Sokolov, Artem V. Arkhipov
Class teachers: Alexandra S. Solovieva, Nadezhda S. Ivanova, Artem V. Arkhipov,
Georgiy G. Okromchedlishvili

Course description
Monetary Economics is a two-semester course designed for the fourth-year stu-
dents studying Economics, and Finance and Banking. It is one of the core
courses taught to the fourth-year students at the ICEF and prepares them for
the University of London final examination on the subject.
The course focuses on the issues of monetary policy implementation in the
closed and open economy contexts. The Fall semester adopts the domestic econ-
omy perspective and covers topics of money creation and monetary transmission
mechanisms, inflation and expectations, neutrality of money. The material pro-
vides students with the theoretical background on the classical and Keynesian
approaches to the monetary policy and discusses their empirical evidence. The
Spring semester examines the term structure of the interest rates and extends
discussion to the international dimension. The most important topics of open
monetary economics are presented: the interest rate and purchasing power par-
ity conditions, the Dornbusch overshooting model, the exchange rates regimes.

Teaching objectives
Monetary Economics course provides students with the theoretical building
blocks that are needed for an understanding of the monetary theory and surveys
the issues in the present-day monetary policy implementation faced by the
central banks. The course equips students with the necessary background to
analyze problems involving the determination of interest and exchange rates in
the economy as well as with the understanding of what central banks can do
to improve the economic performance through the use of the monetary policy
instruments.
The course is a part of the University of London external program and is
taught in English.

Teaching methods
The following methods and forms of study are used in the course:

• lectures

• classes
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• written home assignments (1 per 1–2 weeks)

• teachers’ consultations (2 hours per week)

• self study

The course is taught during two semesters of the 4-th year of education at
ICEF. Lectures are designed to help students to understand the main concepts
of the course. The classes are used to illustrate the theory with references
to policy issues, empirical studies and quantitative tasks. The home assign-
ments have two goals: they prepare the students for the external examination,
and they are used to monitor the students’ progress in the course. The home
assignments have the format of the University of London examination: essay
questions (open-end questions) to analyse a particular problem in detail, quan-
titative problems and true/false/uncertain evaluations of given statements.

Assessment
There are several forms of current, intermediate and final control in the course.
The current control includes written home assignments and class teachers’ eval-
uation of the student participation in the class discussions. The intermediate
control includes the mid-term test in the Fall semester and the Winter exam.
The final control includes the final exam in April and the University of London
examination.

Grade determination
In the Fall semester the grade is given on the basis of the following criteria:

• 10% — home assignments

• 5% — class activity

• 35% — mid-term examination

• 50% — winter examination

The final grade is given on the basis of the following criteria:

• 10% — home assignments in the Spring semester

• 5% — class activity in the Spring semester

• 35% — the first semester grade

• 50% — the final exam

MONETARY ECONOMICS 3

Main reading
1. Lewis M. and Mizen P. Monetary Economics. Oxford. 2002. (LM).

2. Goodhart C. Money, Information and Uncertainty. MacMillan, 1989. (G)

3. Krugman P. and M. Obstfeld. International Economics: Theory and

Policy. Addison-Wesley, 2003. (KO)

4. Miller R., Van Hoose D. Modern Money and Banking. 3d ed., L., 1993.
(Русский перевод: М.,2000) (MH)

5. Mishkin F. The Economics of Banking and Financial Markets. 6th ed.

rev., Boston., 2003. (Mishkin) Русский перевод: Мишкин Ф. Экономическая
теория денег, банковского дела и финансовых рынков. М., 1999.

Internet resources and databases

1. http://econ.lse.ac.uk/courses/ec321/

2. http://mief.hse.ru

3. http://wps.aw.com/aw_mishkin_econmbfm_8

4. http://wps.aw.com/aw_krgmnobstf_interecon_7

Course outline
Basic concepts of Monetary Economics
1. The nature of money

• Defining money by its functions

• Advantages of monetary over the barter economy

• Types of money

LM, ch. 1; G, ch. 2

2. Demand for money

• The quantity theory demand for money

• The Keynes’ speculative demand for money

• The transactions theories of money demand

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• Baumol-Tobin model and the Tobin’s model of portfolio selection

• Empirical evidence

LM, ch. 5–6; 11, 12; G, ch. 3, 4; Laidler D. The Demand for
Money. Harper Collins, 1993.

3. Money supply

• Creation and control of the monetary base by the central bank

• The banking system and financial intermediation

• The base-multiplier approach to money supply determination

• Monetary policy instruments

G, ch. 5, 6 and 10; MH, ch. 4, 5, 6, 8, 9; Mishkin. ch. 15, 16

4. Classical theory of money

• The classical dichotomy and monetary neutrality

• Money in general equilibrium

• Walras’s law and the Patinkin’s critique

• The Real-Balance Effect

LM, ch. 3–4

Monetary Policy in a Closed Economy

5. Money, Inflation and Welfare

• Real and nominal interest rates

• High inflation and hyperinflation

• The Laffer Curve and the inflation tax

• The welfare costs of inflation and the optimal quantity of money

LM, ch. 7; MH, Ch. 21

MONETARY ECONOMICS 5

6. Classical models and monetary policy

• The classical model revisited

• Real business cycle theory
• Lucas misperception model
• Cash-in-advance models

Hoover, K.D. The New Classical Macroeconomics. Blackwell, 1988,

ch. 3. Plosser, C. Understanding Real Business Cycles, Journal of
Economic Perspectives, 1989, Summer.
7. Monetary policy in Keynesian models

• Keynesian aggregate supply function and the Phillips curve

• Menu costs and sticky prices
• Multi-period pricing model

LM, ch. 5
8. Conduct of monetary policy in a closed economy

• Policy ineffectiveness proposition (PIP)

• Rational expectations models and monetary policy
• Lucas critique
• Time inconsistency and inflation bias
• Central bank independence: a discussion
• Friedman’s rule of constant money growth

LM, ch. 9 and 10; MH. Ch. 22; 24; 25; 26

9. The term structure of interest rates

• The yield curve, bond prices and the rate of return

• The expectations hypothesis
• The segmentation hypothesis
• The preferred habitat theory

G, ch. 11, LM, ch. 5; Mishkin. ch. 6

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Monetary Policy in Open Economy

10. Balance of payments, nominal and real exchange rates

• Income accounting in an open economy

• The balance of payments

• Nominal exchange rates

• Real exchange rates

KO, ch. 12; LM, ch. 15

11. Prices and exchange rates

• The law of one price (LOOP)

• Purchasing power parity (PPP)

• Relative purchasing power parity

• Empirical evidence on PPP and the Balassa-Samuelson theory

• The monetary approach to the exchange rate determination

KO, ch. 12 and 15

12. Money, interest rates and exchange Rates

• Uncovered Interest Parity (UIP)

• Covered Interest Parity (CIP)

• Money Market Equilibrium in an open economy

KO, ch. 13 and 14; Mishkin, ch. 8

13. Monetary policy and output in an open economy

• Exchange rate regimes and monetary policy

• The monetary policy coordination amongst countries

• The AA-DD model of an open economy

KO, ch. 16; MH. Ch. 27, 28, 29

MONETARY ECONOMICS 7

14. Exchange rate regimes and monetary unions

• The Gold standard

• The Bretton Woods system

• Flexible exchange rate system

• The currency crises and the ‘vanishing’ intermediate regimes

• Costs and benefits of a monetary union. European Monetary Union

KO, ch. 18, 19, 20; LM, ch. 15

15. Monetary policy in an open economy

• Instruments of monetary policy in the small open economy

• The exchange rate as an intermediate target

• Inflation targeting under flexible exchange rate regime

Mishkin, ch. 18, 20

Distribution of hours

# Topic Total Contact hours Self

hours Lectures Seminars study
1. The nature of money 20 4 4 12
2. Demand for money 20 4 4 12
3. Money supply 20 4 4 12
4. Classical theory of money 28 6 6 16
5. Money, inflation and welfare 24 4 4 16
6. Classical models and monetary 28 6 6 16
policy
7. Monetary policy in Keynesian 24 6 6 12
models
8. Conduct of monetary policy in 20 4 4 12
a closed economy
9. The term structure of interest 20 4 4 12
rates
10. Balance of payments, nominal 20 4 4 12
and real exchange rates
11. Prices and exchange rates 20 4 4 12
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# Topic Total Contact hours Self

hours Lectures Seminars study
12. Money, interest rates, and ex- 20 4 4 12
change rates
13. Monetary policy and output in 20 4 4 12
an open economy
14. Exchange rate regimes and 20 4 4 12
monetary unions
15. Monetary policy in an open 20 4 4 12
economy
Total: 324 66 66 192