Part VI — Money, Banking, and Monetary Policy
The plumbing of the modern economy.
Most people use money every day without thinking about what it is. Most people borrow from banks without thinking about how banks create the money they lend. Most people read about the Federal Reserve and the federal funds rate and the prime rate and quantitative easing without quite understanding how those things connect to the price of milk. The four chapters in Part VI fix that.
By the end of the part, you should be able to explain in plain English what money is, how banks work, why the Federal Reserve exists, what the Fed does when it changes the federal funds rate, and what determines whether prices are stable or rising. You should be able to understand a Federal Open Market Committee statement. You should be able to explain to a friend what happened during the 2008 financial crisis and the 2021–23 inflation surge — and why the Fed responded the way it did each time.
Chapter 26 — Money and Banking opens with the question: what is money? The three functions test (medium of exchange, unit of account, store of value), applied to historical and contemporary candidates. The history of money: barter to commodity to representative to fiat. How banks create money through fractional reserve lending. The structure of the Federal Reserve System and its dual mandate (maximum employment and stable prices). Why banks are fragile (the Diamond-Dybvig model intuitively). Deposit insurance and the moral hazard it creates. Then 2008 as the anchor: shadow banking experienced a modern bank run when short-term funding markets froze. This is the chapter where you first see that 2008 was, in important ways, a 21st-century bank run.
Chapter 27 — Monetary Policy is the longest chapter in Part VI. The Fed's tools (federal funds rate, open market operations, interest on reserves, the discount rate). The transmission mechanism from a rate change to economic outcomes. Quantitative easing and the zero lower bound. The 2008 response, the COVID response, and the 2022–23 rate hike cycle that surprised most forecasters by bringing inflation down without a sharp recession. The chapter is honest about what economists disagree about: rules vs. discretion, the right inflation target, whether monetary policy is too powerful or not powerful enough.
Chapter 28 — The Financial System and Loanable Funds introduces the loanable funds market — saving as supply, investment as demand, the real interest rate as the price. The chapter walks through how government deficits affect the loanable funds market (crowding out, with caveats), the role of bank-based vs. market-based financial intermediation, and the efficient market hypothesis (what it claims, what evidence supports it, and where it breaks down). Why your uncle who "beats the market" is probably either lucky or charging you fees.
Chapter 29 — Inflation: Causes and Consequences treats inflation as a serious topic in its own right. The quantity theory of money (MV = PY) as a long-run anchor. The distinction between demand-pull, cost-push, and expectations-driven inflation. The Phillips curve as a short-run relationship and the famous failure of its long-run version. The Volcker disinflation. The 2021–23 inflation surge as a contested case where multiple stories have evidence. Hyperinflation case studies: Weimar Germany, Zimbabwe, Venezuela.
When you finish Part VI, you understand the monetary side of macroeconomics. Part VII will turn to the fiscal side — and the larger question of why economies experience booms and busts at all.