Unit 9 Flashcards
(23 cards)
What is the opportunity cost of holding cash
cash is convenient, you give up earning interest income if you had it invested
What are short term interest rates
the interest rates on financial assets that mature within a year
What are long term interest rates
interest rates on financial assets that mature a number of years in the future
How do interest rates and the opportunity cost of holding cash relate
The higher the interest rate, the higher the opportunity cost of holding money
The lower the interest rate, the lower the opportunity cost of holding money
What causes shifts in the quantity of cash demanded
Changes in aggregate price level
Changes in real GDP
Changes in technology
Changes in institutions
What is the money demand curve
This shows the relationship between the quantity of cash demanded and the interest rate
What is the liquidity preference model
It is a method of setting interest rates based on the supply and demand for money
How can the FED influence the interest rate
They can change the quantity of money supplied, which would influence the interest rate
What happens when interest rates are high
This means that MS > MD
There is a surplus of money, meaning that there is a shortage of other assets such as bonds. Investors will realise that they can reduce rates on bonds and still find buyers.
What happens when interest rates are low
There is a shortage of money
MD > MS
This means that there is a surplus of other assets such as bonds. To make bonds more attractive they will raise the rates.
Why would investors buy short term bonds even if long term bond rates are higher
This means that they expect the short term rates to increase
E.g. one-year bond at 4% v.s. two-year bond at 5%. You may want to buy the former if you expect interest rate of one-year bond to rise to 8% next year.
What do long-term interest rates reflect
They reflect the markets expectation for short-term rates
What is expansionary monetary policy
monetary policy that increases aggregate demand
How does expansionary monetary policy work
Increase money supply → lower interest rate → higher interest spending raises income → higher consumer spending (via multiplier) –. Increase in aggregate demand and AD curve shifts to the right
What is contractionary monetary policy
Monetary policy that reduces aggregate demand
How does contractionary monetary policy
Decrease money supply → higher interest rate → lower investment spending reduces income → lower consumer spending (via multiplier) → decrease in aggregate demand and AD curve shifts to the left
How do you track monetary policy
The federal funds rate usually rises when the output gap is positive and falls when the output gap is negative
The federal funds rate tends to be high when inflation is high and low when inflation is low
What is the taylor rule of monetary policy
That you should set the federal funds rate according to the level of inflation rate and either the output gap or the unemployment rate
What is inflation targeting
the central bank setting an explicit target for the inflation rate and using monetary policy to hit that target
What are the differences between inflation targeting and taylor rule
inflation targeting is forward looking : taylor rule is backwards-looking
What is monetary neutrality
changes in the money supply have no real effect on the economy
In the long run, changes in the quantity of money affect the price level but not the output or interest rate
In the short run what does an increase in the money supply do
It increases the income of individuals, increasing consumer spending and AD.
MS > MD meaning It lowers interest rates,
In the long run what does an increase in money supply do
The increase in money supply raises wages and nominal prices. As this shifts the money demand, causing a rise in the interest rate, real GDP and saving falls, shifting the loanable funds supply curve back
