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Fiscal policy and monetary policy are the two main tools by which government attempts to steer the macroeconomy toward the three main goals and economic growth.

Monetary policy consists of methods through which the Federal Reserve attempts to engage banks, businesses, and individuals in effecting changes to interest rates, the supply of money, the demand for money, and so forth.

Money serves as a medium of exchange, a store of value, and a unit of account. Those three functions enable individuals to avoid bartering. The ways in which we define and measure money are important to managing an economy. Savings and investment are key elements within the circular flow model and are a function of interest rates.



Upon successful completion, you will be able to:

  • compare and contrast as well as discuss fiscal policy and monetary policy;
  • define the money multiplier, and explain the money creation process;
  • distinguish between the types of money (i.e., between commodity money and fiat money), identifying examples of each;
  • define money supply, and its related definitions (M1 and M2); draw and interpret a money demand curve, and explain how changes in other variables may lead to shifts in the money demand curve;
  • explain and illustrate the relationship between a change in demand for or supply of bonds and macroeconomic activity;
  • explain the functions of a bank, and describe a bank’s balance sheet;
  • explain the primary functions of the Federal Reserve, and describe the three tools it can use as part of monetary policy;
  • explain how the bond market works, and discuss the relationship between bond prices and interest rates;
  • describe the relationships among changes in money demand or money supply, in the interest rate, in the prices of stocks and bonds, in aggregate demand, in real GDP, and in the price level;
  • identify and discuss domestic policies that contribute to economic growth; and
  • explain the linkages among income, consumption, and net investment, relating them to economic growth.