Download Monetary Policy and AD/AS

Monetary Policy and AD/AS
Chapter 20
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
The graphic representation of the effect of
changes in monetary policy and money demand
on interest rate.
Interest
Rate
Money
supply
r1
Equilibrium
interest rate
r2
0
Money
demand
Md1
Quantity fixed
by the Fed
Md2
Quantity of
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
The interest rate is a nominal rate.
Monetary policy targets the Federal
Funds rate (the rate banks charge each
other for over-night loans). Changes in
Interest
this rate indicate to the Fed the
Rate
amount of excess reserves in the Money
banking system.
supply
r1
Equilibrium
interest rate
r2
0
Money
demand
d
M
1
Quantity fixed
by the Fed
d
M
2
Quantity of
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
Interest
Rate
Money
supply
r1
Equilibrium
interest rate
Money
demand
0
d
M
1 Quantity fixed
by the Fed
Money is
defined as M1- Quantity of
spending money
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
This is the quantity of
money made available
in the economy by the
Money Federal Reserve Open
supply Market Committee
(FOMC). Interest rates
do not affect the
money supply.
Interest
Rate
r1
Equilibrium
interest rate
r2
0
Money
demand
d
M1
Quantity fixed
by the Fed
M d2
Quantity of
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
Interest
Rate
Money
supply
The money demand is
the quantity of money
the public is willing to
hold (not save) as cash or
checking deposits.
r1
Equilibrium
interest rate
r2
0
Money
demand
d
M1
Quantity fixed
by the Fed
M d2
Quantity of
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
Interest
Rate
Money Demand consists of two parts: Asset demand (liquidity
theory)- how much money the public wants to hold as a financial
asset for spending purposes; this is determined by interest rates and
moves demand along the curve. High interest rates discourage asset
demand (we prefer to save not spend).
Money
supply
r1
r2
0
Money
demand
Md1
Quantity fixed
by the Fed
Md2
Quantity of
Money
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium in the Money Market...
Interest
Rate
Transaction demand- how much money the public needs in order to buy
available goods and services; this is determined by Nominal GDP and causes
the curve to shift. Higher NGDP would shift the demand curve right.
Another factor would be alternative means of spending such as credit card
use. Higher use of credit cards would shift the curve down. Changes in
money demand changes the interest rate.
Money
supply
Interest
rate 2
Equilibrium
interest rate
MD2
Money
demand
0
Quantity fixed
by the Fed
Quantity of
Money