Interest Rates and Monetary Policy Chapter 14

1
Interest Rates and Monetary PolicyChapter 14

• Starts with the Demand for money
• People demand money for transactions and as an
  asset
• The cost to get money is in terms of interest
  (NOTE in the money market we write interest as
  i for interest paid, remember that the
  Investment Demand curve is represented as r for
  rate of return)

2
Interest Rates and Monetary PolicyChapter 14
(cont.)

• The supply of money is fixed or constant unless
  The Fed changes it, therefore the supply curve
  for money is vertical

MS
i
i1
MD
Q
3
Interest Rates and Monetary PolicyChapter 14
(cont.)

• The Fed can adjust interest rates and, by
  extension, investment demand through increasing
  or decreasing the money supply

MS1
MS3
MS2
i
i2
i1
i3
MD
Q
Qm1
Qm3
Qm2
4
Interest Rates and Monetary PolicyChapter 14
(cont.)
Money Market
Investment Demand
MS1
MS2
r
i
i1
r1
i2
r2
MD
ID
Q
Qm1
Qm2
Q
Qi1
Qi2
5
Interest Rates and Monetary PolicyChapter 14
(cont.)

• What are The Feds most common ways of
  manipulating the money supply?
• Open-Market Operations
• Buying and selling of securities
• The Reserve Ratio
• The Discount Ratethe interest rate that The Fed
  charges for banks to borrow from The Fed
• The Federal Funds Ratethe interest rate that
  banks charge one another to borrow money

6
Interest Rates and Monetary PolicyChapter 14
(cont.)

• Expansionary Monetary Policy or Easy Money
  Policy
• Restrictive Monetary Policy or Tight Money
  Policy
• Draw a money market graph and show the result of
  The Fed selling securities on the market for
  investment demand
• Now show how this change in investment demand
  impacts the macro-economy currently operating at
  the full employment level of output