Chapter Twenty Seven Money Demand, the Equilibrium Interest Rate, and Monetary Policy.

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Presentation transcript:

Chapter Twenty Seven Money Demand, the Equilibrium Interest Rate, and Monetary Policy

Transactions Motive The transactions motive refers to the main reason people hold money… to buy things.

The Nonsynchronization of Income and Spending March 1st April 1st May 1st June 1st Income Spending Time Spending, Income

The Demand Curve for Money Balances Interest Rate 10% 8% 6% Money, M MdMd

Speculation Motive Individuals may choose to hold bonds over money: Because the market value of interest-bearing bonds is inversely related to the interest rate, investors may wish to hold bonds when the interest rates are high with the hope of selling them when interest rates fall.

Total Demand for Money Interest Rate 10% 8% 6% Money, M MdMd Md1Md1 Md2Md2

Determinants of Money Demand interest rate 1. The interest rate dollar volume of transactions 2. The dollar volume of transactions - Aggregate output - The price level

An increase in aggregate output (Y) will shift the money demand curve to the right... Interest Rate 10% 8% 6% Money, M M d (Y 1 ) Md1Md1 Md2Md2 M d (Y 2 )

The Equilibrium Interest Rate Interest Rate r*r* r 1 r 2 Money, M MdMd Md1Md1 Md2Md2 Excess demand for money Excess supply of money Equilibrium Point MSMS

The effect of an increase in the supply of money on the interest rate... Interest Rate 14 8 Money, M MdMd Md0Md0 Md1Md1 M0SM0S M1SM1S Excess supply of money at M 1 s

An Increase in Y Shifts the Money Demand Curve to the Right

The effect of an increase in income on the interest rate M d (Y 1 ) Md1Md1 Md2Md2 M d (Y 2 ) Interest Rate Money, M

An Increase in the Price Level is lake an Increase in Y in that Both Events Increase the Demand for Money. The Result is an Increase in the Equilibrium Interest Rate

Monetary Policy 4 Tight Monetary Policy 4 Tight Monetary Policy is when the Fed uses policies that contract the money supply in an effort to restrain the economy. 4 Easy Monetary Policy 4 Easy Monetary Policy is when the Fed uses policies that expand the money supply in an effort to stimulate the economy.

Review Terms & Concepts 4 Easy monetary policy 4 Interest 4 Interest rate 4 Monetary policy 4 Nonsynchronization of income and spending 4 Speculation motive 4 Tight monetary policy 4 Transaction motive

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