Chapter 11: The Money Market

Question 1

Money demand (2 assumptions)

Answer 1

1) Only 1 interest rate
2) Only 2 ways of storing money:
a) Held as cash (no interest) and as
b) Bonds (pays interest)

Question 2

Bonds

Answer 2

• People lend money to the government that the government pays back later
• Treasury bills mature (pays back) in 1 years or less
• Treasury notes 1 - 10 years
• Treasury bonds 1 - 20 years
• Treasury Inflation Protected Security (TIPS) pays back in either 5, 10, or 30 years

Question 3

Zero coupon bonds

Answer 3

• People pay for bonds and one year later make back profit from the face value of the bond, money made is the discount
• Discount = money you get from bond (face value of bond) - money you paid for bond 1 year ago
• Interest rate = Discount divided by the price you paid for the bond

Question 4

Interest rate equation

Answer 4

Interest rate = Discount (value of bond/money you get - money you paid) divided by the price you paid for the bond

Question 5

Motives to hold money

Answer 5

1. Transactions: Used to buy things
2. Precautionary motive: Emergency money
3. Speculative motive: Money not invested, way of balancing risk, holding cash in case investments don’t pay back

Question 6

Money Demanded equation

Answer 6

Md = f(r, Y, P)

Money demanded = some function of the interest rate, output, and price

Question 7

Change in quantity of money demanded

Answer 7

= Movement along the curve
Caused by change in the interest rate
- Federal Reserve buys bonds (ejects money in) Ms increases, interest rates go down, quantity of money demanded goes up
- Federal Reserve sells bonds (takes money out), Ms decreases, interest rates go up, quantity of money demanded goes down

Question 8

Change in money demanded

Answer 8

Shift of the money demand curve

• Caused by change in output (Y) or change in price (P)
• Y or P go up, demand curve shifts to the right, money demanded increase, interest rate increases
• Y or P go down, demand curve shifts to the left, money demanded decreases, interest rate decreases

Question 9

Change in money supplied

Answer 9

• When the Federal reserve buys bonds (injects money in) money supplied increases, moves to the right, interest rate decreases
• When the Federal Reserve sells bond (takes money out) money suppled decreases, moves to the left, interest rate increases

Question 10

How will a change in the required reserve ratio affect money supplied?

Answer 10

• When the Federal reserve increases the required reserve ratio (banks have less money for loans and therefore doesn’t make as much profit) money supplied decreases, moves to the left, interest rate increases
• When the Federal reserve decreases the required reserve ratio (banks have more money for loans and therefore makes more profit) money supplied increases, moves to the right, interest rate decreases

Question 11

How will a change in the discount rate/window affect money supplied?

Answer 11

• When the Federal reserve increases the discount rate (banks can get more money from the Federal Reserve therefore decreasing the amount of money the Federal Reserve has) money supplied decreases, moves to the left, interest rate increases
• When the Federal reserve decreases the discount rate (banks can’t get as much money from the Federal Reserve) money supplied increases, moves to the right, interest rate decreases

Question 12

Excess demand

Answer 12

• When Md>Ms
• When money demanded is greater than money supplied at a given interest rate
• Occurs underneath equilibrium to the right
• Firms and households will attempt to increase their holdings of money by selling bonds ( want to increase Ms to bring it back to equilibrium)
• Or the interest rate will increase

Question 13

Excess supply

Answer 13

• When Ms>Md
• When money supplied is greater than money demanded at a given interest rate
• Occurs above equilibrium to the left
• Firms and households will attempt to reduce their holdings of money by buying bonds (want to decrease Ms to bring it back to equilibrium)

Question 14

Money multiplier

Answer 14

1/required reserve ratio (as a decimal)

Question 15

Who appoints the Board of Governors?

Answer 15

The President

Question 16

Board of Governors

Answer 16

Jerome Powell (Chair)
7 members 4 taken 3 open
14 year terms
Appointed by President
Meets monthly in DC

Question 17

Excess Reseres Equation

Answer 17

Excess reserves = Actual Reserves - Required Reserves

Question 18

Required Reserves Equation

Answer 18

Required Reserves = Deposits times Required reserve ratio

Question 19

Total Assets Equation

Answer 19

Assets = Actual Reserves/Required reserve ratio

Question 20

Change in money demanded

Answer 20

• As the number of economic transitions increases (Output Y increases), more money will be demanded
• As the number of economic transitions decreases (Output Y decreases), less money will be demanded