Eco 6351 Economics for Managers Chapter 14. Monetary Policy Prof. Vera Adamchik

In Chapter 14 we will focus on: The Demand for Money Interest Rate Determination Controlling the Money Supply Monetary Policy

The Demand for Money Money is a stock - an inventory. There is a limit to how much money we want to hold. The quantity of real money that people plan to hold depends on the interest rate. The quantity of money demanded varies inversely with the interest rate.

Figure shows the demand for money curve. A change in the interest rate brings a movement along the demand curve. The Demand for Money

The Federal Reserve Bank determines the supply of money. At any given point of time, the supply of money is fixed. It is represented by the vertical line labeled MS. The Supply of Money

The interest rate is determined such that the quantity of money demanded equals the quantity supplied. Interest Rate Determination

The Federal Reserve System The Central Bank of the U.S. is the Federal Reserve System. A central bank is a bank’s bank; it is not a citizens’ bank. The Fed conducts the nation’s monetary policy, which means that it adjusts the quantity of money in circulation.

The Fed uses three main policy tools to achieve its objectives. They are: – required reserve ratios – discount rate – open market operations A decrease in the money supply raises interest rates. An increase in the money supply lowers interest rates. Monetary Policy Tools

Influencing Interest Rates Initially, the money supply curve is MS 0. The interest rate is 5 percent.

Influencing Interest Rates Suppose the Fed increases the money supply MS 1. The interest rate falls to 3 percent.

Influencing Interest Rates Suppose the Fed decreases the money supply MS 2. The interest rate rises to 7 percent.