4.5: The money market

the demand for money

at any given time, people demand a certain amount of liquid assets/money.

• Transactional demand for money

• Asset Demand for money

transactional demand for money

people hold money for everyday transactions

asset demand for money

people hold money since it is less risky than other assets

what is the opportunity cost of holding money in your pocket or checking account

The interest you could be earning from other financial assets like stocks, bonds, and real estate

what is the realtionship between interest rate and quantity demanded

inverse

when interest rates increase

quantity demanded falls because people would rather have interest bearing assets instead

when interest rates decrease

quantity demanded increases because there is no incentive to convert cash into interest bearing assets since they will not earn as much interest.

when interest rate decreases

the opportunity cost with holding money in your pocket or checking account also decreases

change in quantity of money demanded is a

movement along the curve

money demand shifters

1. change in price level

2. change in income

3. change in technology

the supply for money

For the US, it is set by the central bank and it is independent from interest rate, meaning it is a vertical line.

When money supply increases

there is a temporary surplus of money at that interest rate causing interest rates to fall

when the money supply decreases

there is a temporary shortage of money at that interest rate causing interest rates to rise

Increases in the money supply on AD

Increase money supply→ decrease ir → increase investment → increase AD

Decrease in the money supply on AD

decrease money supply → increase ir → lower investment → lower AD

federal reserve

regulate banks and make sure people have faith in our financial system

The shifters of money supply

• Reserve Requirement: the percentage of deposits that a bank must hold by law

  • Increase RR, decrease MS

  • Decrease RR, increase MS

• Open market operations: the fed buys and sells government issued bonds to private banks

  • Buy makes MS go bigger, sell makes MS go smaller

• Discount rate: the interest rate that the fed charges banks for loans.

  • Increase DR, decrease MS

  • Decrease DR, increase the MS