WEEK 9 Flashcards
opportunity cost of holding cash =?
interest income that would be collected if that spending power were in an interest-bearing asset (e.g. bond)
short term interest rate
interest rates on financial assets that mature within 6 months or less
long term interest rate
interest rates on financial assets that mature a number of years in the future
money demand curve
relationship between the quantity of money and the nominal interest rate
shifts in money demand curve
- changes in APL (increase APL, increased money demand because need more money to buy goods)
- changes in real GDP (increase real GDP, increase money demand because more consumption requires more money)
- changes in money technology (e.g. credit cards) (increase in money tech, decrease in money demand because don’t hold in cash)
- changes in intstitutions (e.g. after 1980 banks were allowed to offer interest on checking accounts which decreased the cost of holding money and therefore increased money demand)
liquidity preference model of interest rate
asserts that interest rate is determined by money demand and money supply
money demand and supply graph
what happens when the IR is…
- higher than equilibrium
- lower than equilibrium?
- at a higher IR, S>D, surplus of money and a shortage of other assets (e.g. bonds), investors selling bonds will realise they can reduce IR and still find buyers
- at a lower IR, D>S, shortage of money and surplus of other assets (e.g. bonds), investors selling bonds will try to make them more attractive to buys by raising IR
target federal funds rate
Fed’s desired federal funds rate
how does the Fed set the IR?
- through open market operations
- e.g. buy purchasing T-bills, IR decreases
what is the effect of improved transaction technology on…
- money demand
- money supply
- interest rate
- quantity of money?
- shifts left
- movement
- decreased
- unchanged
what is the effect of decreased real GDP and then Fed purchasing T-bills on…
- money demand
- money supply
- interest rate
- quantity of money?
- shifts left when real GDP decreases
- shifts right when Fed purchases T-bills
- decreases
- increases
what is the effect of the Fed purchasing T-bills on…
- money demand
- money supply
- interest rate
- quantity of money?
- shifts right
- movement
- decrease
- increase
what is the effect of an increase in real GDP on…
- money demand
- money supply
- interest rate
- quantity of money?
- shifts right
- movement
- increase
- unchanged
what is the effect of increased APL on…
- money demand
- money supply
- interest rate
- quantity of money?
- shift right
- movement
- increased
- unchanged
do long term IR necessarily move with short term IR?
- no
- if investors expect STIR to increase, will buy STIR
- LTIR reflects market’s average expectation for STIR
expansionary monetary policy
monetary policy which increases AD (aka ‘easy money policy’)
Federal reserve can:
- decrease discount rate
- decreased required reserves
- buy T-bills
- increase money supply
- decrease IR
- increase investment spending which increases incomes
- increases consumer spending via the multiplier
- increases AD
contractionary monetary policy
monetary policy which decreases AD (aka ‘tight money policy’)
Federal reserve can:
- increase discount rate
- increase required reserves
- sell T-bills
- decrease money supply
- increase IR
- decrease investment spending which decreases incomes
- decrease consumer spending via the multiplier
- decrease AD
how does a Central Bank decide whether to use expansionary or contractionary monetary policy?
policy makers try to:
- fight recessions
- ensure price stability, i.e. low inflation
usually combo of these goals
federal funds rate tends to…
- rise when there is a positive output gap
- fall when there is a negative output gap
- be high when inflation is high
- be low when inflation is low
why do changes to money supply affect APL but not output in the long run?
- increase in money supply reduces IR and increases AD
- eventual rise in nominal wages leads to decrease in SRAS so aggregate output falls back to potential output
money neutrality
changes in money supply have no real effect on the economy
why do changes in the money supply not affect IR in the long run?
- increase in money supply decreases interest rate in the short run
- in the long run increase in APL leads to increase in money demand so IR returns to original level
what is the effect of depositing money from the sale of stocks into a checking account?
M1/M2 increases because checking account is a part of M1 (and therefore m@)
