Econ 4.3

Monday, March 22, 1999

Announcements: Chapter 10 and Chapter 11 homeworks are due on Wednesday. Dr. Fox was out today.

Lecture notes:  

The Supply of Money

• Vertical line because it is completely determined (set) by the Fed
• Fed changes the M^S (shifts the curve) by changing the required reserve ratio, or by engaging in open market operations
  • Increase (decrease) in rr --> decrease (increase) in M^S
  • Fed buys (sells) bonds --> increase (decrease) in M^S

Chapter 12: Money Demand, The Equilibrium Interest Rate, and Monetary Policy

• Chapter 12 combines money supply with demand for money
• The demand for money does not mean how much money you would like to have, but rather how much of your financial assets you would like to hold as cash (ie. non-interest bearing securities)

Total Demand For Money

• Transactions Motive: The transactions motive refers to the main reason people hold money to buy things. Reasons why demand for money is downward sloping.
• Speculative Motive: Individuals may choose to hold bonds over money, because the market value (or price) of interest bearing bonds is inversely related to the interest rate, investors may wish to hold bonds when the interest rates are high with the hope of selling them when interest rates fall.

Determinants of Money Demand

• 1. The interest rate (movement along curve - negative relationship)
• 2. The dollar volume of transactions (shift in the curve -- positive relationship)
  • Aggregate Output
  • The Price Level
• An increase in aggregate output (Y) or an increase in the price level will shift the money demand curve to the right
• See Figure 12.5 on page 259 in the textbook
• How is the interest rate determined?
• See Figure 12.6 on page 261 in the textbook
• What happens when an increase in Y or the price level shifts the money demand cruve to the right?
• The effect of an increase in income or the price level of the interest rate

Monetary Policy

• Tight monetary policy is when the Fed uses policies that contract the money supply in an effort to restrain the economy
• Easy monetary policy is when the Fed uses policies that expand the money supply in an effort to stimulate the economy
• Fed decides to conduct easy (expansionary) monetary policy to stimulate the economy either by decreasing the reserve ratio or buying bonds. This leads to a decrease in the interest rate.

How Monetary Policy Affects GDP

• Easy Monetary Policy
• in M^S in r in I_P in GDP
• Tight Monetary Policy
• in M^S in r in I_P in GDP