The Money Market. A.P. Economics Unit 4: Financial Sector. Ms. Trimels

Transcription

1 The Money Market A.P. Economics Unit 4: Financial Sector Ms. Trimels

2 The Money Supply (Sm) A nation s money supply: the amount of money available to households and firms at any particular time. It measures the total amount in a nation held as cash, coins, and checking accounts. The money supply impacts several macroeconomic indicators: Interest rates Private investment Inflation The money supply is determined primarily by a central bank (the Fed) using monetary policy.

3 The supply of money is vertical (inelastic) It is determined by the monetary policy actions of the central bank It is independent of the nominal interest rate (Rn) The nominal interest rate: The price of money Reflects the cost of borrowing money What must be paid in addition to the amount borrowed Reflects the opportunity cost of spending money What would be given up by not saving Nominal Interest Rate (Rn) Money Supply (Sm) Quantity of Money (Qm)

4 The Money Demand (Dm) There are two reasons money is demanded in an economy: 1. To use an asset to preserve wealth in liquid form for the future 2. To use in transactions in the product or resource markets

5 1. Asset Demand Money is an asset itself; it is a store of value for future use Money can be kept as an asset by households or firms to acquire goods, services, or resources at some time in the future. Qm

6 cont. At lower ir, households and firms will demand more money the opportunity cost of holding money is less when there is less interest to be earned by holding wealth in less liquid forms, like Savings accounts Time deposits Bonds Qm

7 2. Transaction Demand Transaction demand for money refers to demand for liquidity with which to engage in the purchase of goods and services. (You want money to buy stuff). At any given time, it is assumed that price levels and the velocity of money are stable The transaction demand for money is only dependent on the level of output (Y) in an economy Therefore, the curve is vertical. Qm

8 The Money Market The money market combines the supply of money (Sm) and the demand for money (Dm) in a nation s economy. Nominal Interest Rate (Rn) IRe (Sm) (Dm) Quantity of Money (Qm)

9 The Money Market (cont.) Money supply (Sm) is determined by the efforts of the Fed and includes all of the money held as currency or as checkable deposits in a nation. Sm is vertical and unresponsive to changes in the ir Nominal Interest Rate (Rn) IRe (Sm) (Dm) Quantity of Money (Qm)

10 The Money Market (cont.) Money demand (Dm) is the sum of the asset and transaction demand for money in a nation. Dm is inversely-related to ir. The equilibrium nominal interest rate (Rn) in a nation is found at the intersection of Sm and Dm. Nominal Interest Rate (Rn) IRe (Sm) (Dm) Anything that changes Sm or Dm will lead to a change in the nominal interest rate... Quantity of Money (Qm)

11 Example #1 An increase in the nominal GDP (Y) will lead to an increase in the transaction demand for money. Dm shifts right Assuming there is no change in the Sm from the Fed, this will drive up ir Banks can charge a greater fee for borrowers Banks offer a larger ir to depositors to encourage deposits. Rn IR 1 IRe Sm Dm 1 Dm Qm

12 Example #2 A fall in national output (Y) will lead to a decrease in the transaction demand for money. Dm shifts left Assuming there is no change in the Sm from the Fed, this will drive down ir Banks are willing to make loans to scarce borrowers at a lower rate for their less-demanded deposits. Rn IRe IR 1 Sm Dm 1 Dm Qm

13 Example #3 An increase in the Sm due to a change in monetary policy by the Fed will lead to a decrease in Rn. Sm shifts right A central bank policy expands the supply of excess reserves in commercial banks Usually done by buying gov t bonds from those banks The funds the central bank paid for the bonds are now excess reserves for the bank and can be lent out to create money. Money is less scarce Banks make loans at lower ir banks pay lower returns to depositors Rn IRe IR 1 Sm Sm 1 Dm Qm

14 Example #4 An decrease in the Sm due to a change in monetary policy by the Fed will lead to a increase in Rn. Sm shifts left A central bank policy reduces excess reserves in commercial banks Usually done by selling gov t bonds to banks Increased scarcity of money banks charge higher ir to borrowers reward depositors with a higher ir on their deposits. Rn IR 1 IRe Sm 1 Sm Dm Qm