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Chapter 33
Interest Rates and
Monetary Policy
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Interest Rates
•
•
•
•
Price paid for the use of money
Many different interest rates
Speak as if only one interest rate
Determined by money supply and
money demand
33-2
Demand for Money
• Why hold money?
• Transactions demand, D1
–Determined by nominal GDP
–Independent of the interest rate
• Asset demand, D2
–Money as a store of value
–Varies inversely with the interest
rate
• Total money demand, Dm
33-3
Central Banks
Selected Nations
Australia:
Canada:
Euro Zone:
Japan:
Mexico:
Russia
Sweden:
United Kingdom:
United States:
Reserve Bank of Australia (RBA)
Bank of Canada
European Central Bank (ECB)
Bank of Japan (BOJ)
Banco de Mexico (Mex Bank)
Central Bank of Russia
Sveriges Riksbank
Bank of England
Federal Reserve System (the “Fed”)
(12 Regional Federal Reserve Banks)
33-4
Monetary Policy
• Expansionary monetary policy
–Economy faces a recession
–Lower target for federal funds rate
–Fed buys securities
–Expanded money supply
–Downward pressure on other
interest rates
• Contractionary monetary policy
33-5
Expansionary Monetary Policy
CAUSE-EFFECT CHAIN
Problem: unemployment and recession
Fed buys bonds, lowers reserve ratio, lowers the
discount rate, or increases reserve auctions
Excess reserves increase
Federal funds rate falls
Money supply rises
Interest rate falls
Investment spending increases
Aggregate demand increases
Real GDP rises
33-6
Restrictive Monetary Policy
CAUSE-EFFECT CHAIN
Problem: inflation
Fed sells bonds, increases reserve ratio, increases
the discount rate, or decreases reserve auctions
Excess reserves decrease
Federal funds rate rises
Money supply falls
Interest rate rises
Investment spending decreases
Aggregate demand decreases
Inflation declines
33-7