Untitled Flashcards Set

Money demand - The demand for money is the sum of money demanded transactions and money demanded as an asset. It is inversely related to the nominal interest rate.

Shifters of the Demand for Money Curve

Price Level

Real GDP

Transaction Costs

The Supply of Money

The monetary base of a nation is determined by the country’s central bank (FED).

Money supply is independent of the nominal interest rate.

The Federal Reserve has three general tools of monetary policy that they control:

Engaging in open market operations

Changing the discount rate

Changing the required reserve ratio

Money Market Equilibrium

The money market is the interaction among institutions through which money is supplied to individuals, firms, and other institutions that demand money.

Money market equilibrium occurs at the interest rate at which the quantity of money demanded is equal to the quantity of money supplied.

Investment Demand

It is the desired quantity of investment spending by firms across the economy on physical capital and other resources for the pe productivity/profitability.

There is an inverse relation between the nominal interest rate and the quantity of investment demanded.

Expansionary monetary policy - Designed to fix a recession by lowering interest rates to increase aggregate demand, lower the unemployment rate, and increase real GDP, which may increase the price level.

By increasing the money supply, the interest rate gets lower. Lower interest increases private consumption and investments, which shifts the AD curve to the right

Contractionary monetary policy - Designed to avoid inflation by increasing interest rates to decrease aggregate demand, which lowers the price level and decreases real GDP back to full employment.

When the money supply is decreased, the interest rate increases causing a decrease in private consumption and investment shifting AD to the left.

Open market operations (OMOs) - A traditional tool of monetary policy, it involves the Fed’s buying (or selling) of securities from (to) commercial banks and the general public.

When securities (Treasury bonds) are bought from the banks by the Fed, the banks receive excess cash and the Fed gets bonds. When banks have excess reserves, the money supply increases and the interest rate falls.

The opposite happens when the banks buy securities from the Fed. The banks get the bonds and their excess reserves would fall causing the money supply to decrease increasing interest rates.

Federal funds rate - The interest rate paid on short-term loans made from one bank to another. When this rate is a target for an OMO, bonds are bought or sold accordingly until the interest rate target has been met.

If the FOMC wants to lower interest rates, it buys bonds.

If the FOMC wants to rise interest rates, it sells bonds.

Discount rate - The interest rate commercial banks pay on short-term loans from the Fed.

Lowering the discount rate (or federal funds rate) increases excess reserves in banks and expands the money supply.

Raising the discount rate (or federal funds rate) decreases excess reserves in commercial banks and contracts the money supply.

Required Reserve Ratio -

Lowering the reserve ratio increases excess reserves in commercial banks and expands the money supply.

Increasing the reserve ratio decreases excess reserves in commercial banks and contracts the money supply.

The demand of Loanable Funds

It is the quantity of credit wanted and needed at every real interest rate by borrowers in an economy.

The relationship between real interest rates and the number of loanable funds demanded is inverse.