Financial market

Question 1

What are the two financial assets?

Answer 1

Money and bonds

Question 2

What would make someone hold more money than bonds?

Answer 2

If the interest rate was low (therefore there was a low return) and you had a high level of transactions.

Question 3

What is the overall demand for money dependent on? (without banks)

Answer 3

Nominal income and the real interest rate

Question 4

At a given nominal income, what happens when the demand for money increases?

Answer 4

The interest rate falls.

Question 5

At a given interest rate, what happens when nominal income increases?

Answer 5

Money demand increases (shifts to the right on demand for money diagram)

Question 6

What does equilibrium in the money market require?

Answer 6

Money supply equals money demand (this is the LM relation)

Question 7

This equilibrium is effected by changes in what?

Answer 7

Nominal income

Question 8

What happens to the equilibrium with an increase in nominal income, when money supply is fixed?

Answer 8

Money demand increases (due to the increase in transactions from the increase in nominal income) and this increases the interest rate.

Question 9

What happens to the equilibrium when money supply increases?

Answer 9

The interest rate falls. This increases the demand for money so it equals the now larger supply of money

Question 10

How does the Central Bank control money supply and what is this called?

Answer 10

By buying and selling bonds on the bond market. This is called Open Market Operations

Question 11

What is the CB balance made up of?

Answer 11

Assets (bonds) and liabilities (money)

Question 12

What is an expansionary open market operation?

Answer 12

When the central bank buys bonds to increase the supply of money (an increase in liabilities increases assets by the equal amount)

Question 13

What is the price of a bond?

Answer 13

Return/(1+i)

Question 14

What happens to the price of bonds in an expansionary open market operation?

Answer 14

The price of bonds increases (due to the increase in demand for bonds), therefore the interest rate on bonds decrease

Question 15

What are private banks?

Answer 15

Institutions that receive funds from people or firms and use these funds to buy bonds or to make loans to other people or firms

Question 16

Why do banks keep reserves?

Answer 16

To honor depositors withdrawals, to pay other banks back (people write cheques to other banks) and to maintain the legal reserve ratio requirement

Question 17

What is the monetary base?

Answer 17

Its the money created by the CB and consists of currency and reserves held by banks

Question 18

What are the assets and liabilities of private banks?

Answer 18

Liabilities: checkable deposits (people can withdraw in any moment)
Assets: Reserves, loans and bonds

Question 19

What is the demand for central bank money equal to?

Answer 19

Demand for currency by people and demand for reserves by banks

Question 20

How do you determine equilibrium interest rate?

Answer 20

Demand and supply of CB money is equal

Question 21

What does demand for money now consist of?

Answer 21

How much you hold in currency and how much you hold in an deposit account

Question 22

What are the currency demand and deposit account demand equations?

Answer 22

CUd=cMd
Dd=(1-c)Md
c being a fixed proportion

Question 23

What is the demand for reserves equation?

Answer 23

Rd=sD
s being the reserve rate and D being deposits
Therefore:
Rd=s(1-c)Md

Question 24

Whats the demand for CB money equation?

Answer 24

Hd=CUd+Rd
Therefore:
Hd=(c+s(1-c))Md

Question 25

What does a higher interest rate imply?

Answer 25

A lower demand for CB money because theres a lower demand for currency and the demand for deposit accounts goes down (therefore a lower demand for reserves)

Question 26

Whats the money multiplier?

Answer 26

Increases in monetary base lead to more than one-for-one increases in overall supply of money. The ultimate increase in the money supply is a result of successive rounds of purchases of bonds

Question 27

If people hold only deposits, then what is c?

Answer 27

c=0, H=sPY.L(i)

Demand for central bank money (for reserves) is equal to s of the overall demand for money.

Question 28

How could the central bank control money supply?

Answer 28

Indirectly through the control of the monetary base (H)