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Equilibrium Income Keynesian Approach: AE d determines Y (income/output) produced Can there be limitations to this link? YES because interest rates and/or.

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Presentation on theme: "Equilibrium Income Keynesian Approach: AE d determines Y (income/output) produced Can there be limitations to this link? YES because interest rates and/or."— Presentation transcript:

1 Equilibrium Income Keynesian Approach: AE d determines Y (income/output) produced Can there be limitations to this link? YES because interest rates and/or prices might change that will reduce the effect on Y.

2 Interest Rates Interest rates are determined by the supply and demand of loanable funds. Let’s take a closer look at this market. Money Market Financial MarketBond Market Equities Market

3 Money Market What is money?

4 Historical Development of Money No Money: Barter Economy (goods for goods) Money as a medium of Exchange: GoodsMoney Goods How did all start? – Precious metals, – Paper money backed by gold, – Paper money fractionally backed by gold, – Fiat money,

5 Properties of a Good Medium of Exchange 1.Acceptable 2.Standardized quality 3.Durable 4.Valuable relative to its weight 5.Divisible

6 The Functions of Money 1) Medium of Exchange 2) Unit of account 3) Store of Value 4) Standard of deferred payments

7 Money Supply Today Money supply (M1) Currency (in circulation) + demand deposits (TL and Foreign Currency) Money supply (M2) M1 + Time deposits (TL and Foreign Currency)

8 M1 and M2 in Turkey

9 US Money Supply

10 Can the Central Bank change MS? YES!!! HOW? – With some tools known as monetary policy tools. (Tools are instruments that a policy maker can change in order to influence the workings of an economy)

11 Monetary Policy Tools 1.Discount Rate, 2.Reserve Requirement ratio, 3.Open Market Operations. How do they work? Need to look at how banking system work and money changes hands…

12 Commercial Banks Banks are profit seeking institutions. – They accept deposits, – They give loans Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti …)

13 Commercial Banks Balance Sheets AssetsLiabilities ReservesDeposits LoansShort and long term borrowing Building and EquipmentOther Liabilities Other Assets Total Liabilities Stock holders equities Total AssetsTotal liabilities + stock holders’ equities

14 Rules that commercial banks follow: Hold the required reserve ratio determined by Central Bank. If required reserve ratio (rr) is 15%, then in equilibrium (Reserves/ Deposits)*100 ratio=15 %. e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL. (Reserves/ Deposits)*100 ratio=(300/2000)*100=15 %

15 A new deposit comes into Bank One Change AssetsChange Liabilities Reserves +1000Deposits Loans Total Assets +1000Total Liabilities +1000

16 Bank One uses this new deposits in giving out new loans (Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850. Change AssetsChange Liabilities Reserves + 150Deposits Loans Total Assets +1000Total Liabilities +1000

17 The new loan comes back to Bank Two Change AssetsChange Liabilities Reserves +850Deposits +850 Loans Total Assets +850Total Liabilities +850 Change AssetsChange Liabilities Reserves (850*0.15)Deposits +850 Loans (850*0.85) Total Assets +850Total Liabilities +850 New loans of TL are created by Bank Two

18 This will repeat ∞ times Total change in the deposits: (0.85*1000)+(0.85*1000) 2 +(0.85*1000) 3 +… (0.85*1000) ∞ = Total change = Change in total deposits=

19 Money supply Money market Tools to increase the MS 1)Discount rate increase, 2)Reserve requirement ratio decrease, 3)Open Market Operations (Buy bonds) I Q of money

20 Money demand Money market Types of Money demand 1)Transaction demand, 2)Speculative demand, 3)Precautionary demand, MD= L(Y, i) or MD= 5*Y – 3*i I Q of money

21 Money demand Money market If Y increases, then MD curve shifts to the right MD= L(Y, i) or MD= 5*Y – 3*i I Q of money

22 Money market equilibrium Money marketMS=MD Money supply MS= 1000 Money demand MD= L(Y, i) or MD= 5*Y – 3*I (For a given Y level you will be able to determine equilibrium interest rate) I Q of money


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