Chapter 15.2: Money and Interest Rates Flashcards
What is monetary policy?
Changes in the quantity of money in circulation designed to alter interest rates and affect the overall level of spending.
What is the overnight rate?
The rate at which banks lend excess reserves to each other generally for one business day or less (unless a longer term is negotiated).
How does the Bank of Canada achieve a target overnight rate set by the Governing Council (aka increase or decrease the money supply)?
Open-market operations - buying and selling government bonds, (in practice, short-term treasury bonds). It can also lend via the bank rate, use foreign exchange market intervention, pursue government deposit switching, or buy and sell other assets.
What is the liquidity preference model of the interest rate?
A model of the market for money in which the interest rate is determined by the supply and demand for money.
What is the money supply curve?
A graphical representation of the relationship between the quantity of money supplied by the Bank of Canada and the interest rate.
Why does the money demand curve slope downward?
A higher interest rate leads to a higher opportunity cost of holding money and reduces the quantity of money demanded.
Where does the money supply curve sit on a graph?
Vertical at the money supply chosen by the Bank of Canada (based on what it believes will achieve the target overnight rate).
What happens if the interest rate is below the interest rate equilibrium and the public wants to hold a quantity of money that is larger than the actual money supply?
- The quantity of money demanded is more than the quantity of money supplied.
- The quantity of interest-bearing assets demanded is less than the quantity supplied.
So those trying to sell non-money assets, such as issuers of bonds, will find they have to offer higher interest rates to attract buyers. As a result, the interest rate will be driven up from the original point, until the public wants to hold the quantity of money that is actually available. That is, the interest rate will rise until it reaches the interest rate equilibrium.
What happens if the interest rate is above the interest rate equilibrium?
The quantity of money demanded is less than the quantity of money supplied. Correspondingly, the quantity of interest-bearing money assets demanded is greater than the quantity supplied. Those trying to sell interest-bearing non-money assets will find that they can offer a lower interest rate and still find willing buyers. This leads to a fall in the interest rate from the original point, until the public wants to hold the quantity of money that is actually available. That is, the interest rate will fall until it reaches the interest rate equilibrium.
An increase in the money supply…
Leads to a fall in the interest rate.
A reduction in the money supply…
Leads to a rise in the interest rate.
What happens when the overnight rate changes?
Since the overnight rate is a trend-setting interest rate, all short-term interest rates change.
What are the central banks equivalent to the Bank of Canada in the US, England, the EU, Japan, and Australia?
US: Federal Reserve of the United States
England: Bank of England
EU: European Central Bank
Japan: Bank of Japan
Australia: Reserve Bank of Australia
An open-market purchase of Treasury bills…
Drives the interest rate down (via the money multiplier) and the money supply curve shifts rightward.
An open-market sale of Treasury bills…
Drives the interest rate up (via the money multiplier) and the money supply curve shifts leftward.
