week5 Flashcards
what is the relationship between financial asset prices and interest rates?
its an inverse relationship
if the interest rates increase the value of a price assets producing an income will decrease
An increase in the price of an asset producing a given income stream is equivalent to a
decrease in the interest rate earned on that asset
what is Keynesian theory of liquidity preference ?
According to the theory, the interest rate adjusts to equate the supply and demand for money. and the demand for money is influenced by the desire for liquidity
why would people hold money?
▶ Transactions motive to buy goods and services
▶ Precautionary motive if the opportunity arises to buy a good or service people want to have
enough money on hand
▶ Asset or speculative motive to invest into good investment opportunities in the near future
what is the opportunity cost of holding money?
the interest that could have been earned if the money had instead been used to buy financial assets
What factors determine the level of nominal money demand
▶ Prices
▶ Real income
▶ Interest rates
what determines the level of real money demand?
▶ Real income
▶ Interest rates
whats the difference between real and nominal money?
Nominal money refers to the face value or currency amount of something. real money reflects the actual purchasing power of that money, taking into account inflation
what is the relationship between money demand and the interest rates?
its inverse
if interest increases the demand for real money will decrease this is because the opportunity cost of receiving high interest will be too high
what is the relationship between money demand and real income?
as real income increases the motive for money will increase as more disposable income
what happens when there is an excess supply of money?
More money available than individuals want to hold, so buy assets which pushes up their price and decreases the interest rate
this keeps on happening till return to equilibrium
what happens when there is an excess demand for money?
▶ Less money available than individuals want to hold, so sell assets which pushes down their price and increases the interest rate
this keeps on happening till return to equilibrium
what happens in the money supply if there in an increase in money supply ?
the money supply curve which is fully inelastic will shift to the right and thus individuals will buy more assets and thus decrease the interest rates
what happens in the money supply if there in an decrease in money supply ?
the money supply curve which is fully inelastic will shift to the left and thus individuals will sell more assets and thus interest rates will increase
what are the three ways the central bank can influence money supply at M4 (a measure of broad money supply that includes notes and coins in circulation, plus all sterling deposits held with UK banks and building societies by the rest of the private sector)
open market operations. either change interest rates to alter money supply or alter money supply to alter interest rates
set reserve requirements
set base rate of money
what is a repo?
a sale and a repurchase payment
The Central Bank buys a bond from you with a simultaneous agreement to sell it back to
you at a specified price at a specified future date
for the uk what is the monetary instrument
monetary policy instrument is the interest rate
the monetary instrument decisions are guided by indicators known as the intermediate targets what is the intermediate targets
an inflation target
what is needed as a precondition for high and stable levels of growth and employment?
price stability
how is the price stability set by the uk government
inflation target
normally 2% plus or minus 1%
what is the Keynesian liquidity trap
this is when increased money supply fails to lower interest rates
central bank tries to lower interest rates by increasing the money supply. This is achieved by buying assets with newly created deposits
assets pay little to no interest making them almost equivalent to cash holdings
when in a liquidity trap then the increased money supply will fail to reduce interest rates
thus unable to stimulate economic activity
if the central bank is concerned with low inflation but cutting interest rates dont alter inflation what should they do?
quantitative easing
what is quantitative easing
a tool used by central banks to stimulate economic growth
involves the central bank buying financial assets, primarily government bonds, from the private sector, effectively creating new money to inject into the economy.
