We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What is a Monetary Model?

By Danielle DeLee
Updated: May 17, 2024
Views: 8,339
Share

A monetary model is a way of describing the monetary side of the economy: the interaction between people’s spending and the supply of money the government creates. Policymakers use these models to understand the effects their choices will have on the economy. These models are particularly relevant in predicting the fluctuations of exchange rates as a result of monetary policy.

Monetary policy is one tool governments have at their disposal. Another is fiscal policy, which uses government spending in various sectors to encourage growth in the economy. When the government uses monetary policy, it targets either a certain level of money supply or a certain interest rate. Policymakers use a monetary model to estimate the effect a change in monetary policy will have on other economic variables.

There are two main types of monetary models that policymakers use to model the behavior of exchange rates. One is the flexible monetary model, which assumes that prices react instantly to changes in monetary policy. In a flexible model, purchasing power parity is assumed, which means a certain amount of currency will buy the same amount of goods as will any amount of currency it can be exchanged for. This means that when prices adjust in response to new policies, exchange rates change as well.

The other kind of monetary model is a sticky price model. According to this type of model, when changes to national monetary policy are announced, prices do not respond right away. This is a reasonable expectation because shopkeepers are relatively slow to react to investment news, and they often hold prices at a fairly stable level to avoid alienating customers. Exchange rates, however, adjust quickly because they are determined by investment behavior, and investors are sensitive to policy changes. Thus, under this type of model, changes to the money supply affect people’s real income levels.

Like all models, monetary models are simplified ways of representing actual behavior. To be effective, a model must be complicated enough to give useful results. It must be simple enough, however, to be understandable. The more complex a model is, the closer it is to the real world, but the cause of observed effects is more difficult to determine in more complicated systems.

Using the predictions of a monetary model, the government can adjust its monetary policy to achieve its objectives using various methods. One common method is carried out by the circulation desk of a country’s central bank, which controls the money supply. The desk staff, at the direction of policymakers, can buy or sell bonds to contract or expand the money supply. The government can also change the interest rate at which it lends money to banks, which acts as a benchmark rate for other lending.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.

Editors' Picks

Discussion Comments
Share
https://www.wisegeek.net/what-is-a-monetary-model.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.