Monetary Theory

Home/ Monetary Theory
Course TypeCourse CodeNo. Of Credits
Foundation ElectiveSLS2EC2174

Semester: II Semester

Course Coordinator and Team: Dr. Jyotirmoy Bhattacharya & Dr. Parag Waknis
Email of the Course Coordinator:
Pre-requisite: Macroeconomics I & II
Aim: Starting with the quantity theory of money the course will examine alternative approaches of looking at the
role of money in the macroeconomy in a broadly chronological sequence. The challenge of identifying the
effects of monetary policy from purely observational data will be one of the unifying themes of the course.
The course will also emphasize the need to study monetary policy as a long-run interaction between the
monetary authority and the private sector rather than as a sequence of one off choices of policy actions.
Course Outcomes
At the end of the course students should be able to:

  1. describe the various schools of thought in empirical monetary theory and policy.
  2. describe the importance of Lucas critique in influencing the empirics of monetary policy.
  3. evaluate evidence on effect of money on prices and output using VARs.
  4. analyse the effects of monetary policy changes using a New Keynesian Model.
  5. describe the nature of optimal monetary policy in terms of the rules vs. discretion debate.

Topics & Readings:
1. The monetarist-Keynesian debates. The quantity theory of money: historical background. Similarities
and differences between monetarism and the neoclassical synthesis. The problem of identification in
testing alternative monetary theories.1

  • Gordon, R.J (ed.). 1975. Milton Friedmans Monetary Framework: A Debate With His Critics. University of Chicago Press Journals.
  • Hume, D. 2006. Essays: Moral, Political and Literary. Cosimo Classics. Patinkin, D. 1989. Money, Interest and Prices, 2nd ed. MIT Press.
  • Tobin, J. 1970. Money and Income: Post Hoc Ergo Propter Hoc?, Quarterly Journal of Economics, 84(2), 301-317.

2. New classical monetary economics. The Lucas critique and rational expectations. The need to model
monetary policy as feedback rules.

  • Lucas, R.E. (ed.). 1983. Studies in Business Cycle Theory. MIT Press.
  • Miller, P.J. (ed.) 1994. The Rational Expectations Revolution: Readings from the Front Line, MIT Press
  • Sargent, T.J. and Wallace, N. 1975. Rational Expectations, the Optimal Monetary Instrument and the Optimal Money Supply Rule, Journal of Political Economy, 83(2), 241-254.

3. Current evidence on money, prices and output. Vector autoregressions. Alternative identification
strategies. Other evidence.

  • Christiano, L.J. and Eichenbaum, M. and Evans, C.L. 1999. Monetary policy shocks: What have we learned and to what end? in Taylor, J.B. and Woodford, M. (ed). Handbook of Macroeco- nomics, Vol. 1A, North Holland.
  • Leeper, E.M., Sims, C.A. and Zha, T. 1996. What Does Monetary Policy Do?, Brookings Papers on Economic Activity, No. 2, 1-78. Romer, C.D and Romer, D.H. 1989. Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz, NBER Macroeconomics Annual, 4, 121-170.
  • Sims, C. 1980. Macroeconomics and Reality, Econometrica, 48(1), 1-48.
  • Uhlig, H. 2005. What are the Effects of Monetary Policy on Output? Results from an Agnostic Identification Procedure, Journal of Monetary Economics, 52(2), 381-419.

4. The new-Keynesian framework. Empirical evidence and alternative explanations for price and wage
stickiness. The new-Keynesian Phillips curve. Extending the new-Keynesian framework to fit the data
better. Alternatives.

  • Bernanke, B.S, Gertler, M. and Gilchrist, M. 1999. The Financial Accelerator in a Quantitative Business Cycle Framework in Taylor, J.B. and Woodford, M. (ed). Handbook of Macroeconomics, Vol. 1A, North Holland.
  • Clarida, R., Gali, J. and Gertler, M. 1999. The Science of Monetary Policy: A New-Keynesian Perspective, Journal of Economic Literature, 37(4), 1661-1707.
  • Klenow, P.J. and Malin, B.A. 2010. Microeconomic Evidence on Price Setting in Friedman, B.M. and Woodford, M. (eds.) Handbook of Monetary Economics, Vol. 3A, North Holland, 231-284.
  • Mankiw, N.G. and Reis, R. 2002. Sticky Information vs. Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve, Quarterly Journal of Economics, 117(4), 1295-1328.
  • Rudd, J. and Whelan, K. 2007. Modeling Inflation Dynamics: A Critical Review of Recent Research, Journal of Money, Credit and Banking, 39, 155-170.
  • Sims, C.A. 2003. Implications of Rational Inattention, Journal of Monetary Economics, 50(3), 665-690.
  • Smets, F. and Wouters, R. 2003. An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area, Journal of the European Economic Association, 1(5), 1123-1175. 2

5. Optimal monetary policy: Targets and instruments of monetary policy. Rules vs. discretion. Inflation

  • Ball, L. 2010, The Performance of Alternative Monetary Regimes in Friedman, B.M. and Wood- ford, M. (eds.) Handbook of Monetary Economics, Vol. 3B, North Holland.
  • Barro, R.J. and Gordon, D. 1983. Rules, Discretion and Reputation in a Model of Monetary Policy, Journal of Monetary Economics, 12(1), 101-121.
  • Clarida, R., Gali, J. and Gertler, M. 1999. The Science of Monetary Policy: A New-Keynesian Perspective, Journal of Economic Literature, 37(4), 1661-1707.
  • Eggertson, G.B. and Woodford, M. 2003. The Zero Bound on Interest Rates and Optimal Mone- tary Policy, Brookings Papers on Economic Activity, No. 1, 139-211.
  • Svensson, L.E.O. 2010. Inflation Targeting in Friedman, B.M. andWoodford, M. (eds.) Handbook of Monetary Economics, Vol. 3B, North Holland.

Grading Scheme:
Your final grade will be determined as follows:

ComponentPercentage Contribution
Presentations (a guided presentation based on a research article)30%
Exams 1 (a class test based on material covered during first half of the semester.)35%
Exams 2 (a class test based on material covered during first half of the semester.)35%