Chapter 4Financial Market 1: The Demand for Money 4-2. The determination of the Interest Rate: I 4-3 The determination of the lnterest Rate: II 2003-6-29
2003-6-29 1 Chapter 4:Financial Market 4-1:The Demand for Money 4-2:The Determination of the Interest Rate:Ⅰ 4-3: The Determination of the Interest Rate:Ⅱ
4-1:The Demand for Money Assume that you the choice between only two financial assets OMoney, which can be used for transactions, but pays zero interest. In reality, there are two types of money currency, the coins and bills issued by the central bank, and checkable deposits, the bank deposits on which you can write checKs OBonds, which cannot be used for transactions, but pay a positive interest rate, In reality there are many other assets than money, and in particular many types of bonds each associated with a specific interest rate 2003-6-29
2003-6-29 2 4-1:The Demand for Money Assume that you the choice between only two financial assets: ●Money , which can be used for transactions, but pays zero interest. In reality, there are two types of money: currency,the coins and bills issued by the central bank, and checkable deposits, the bank deposits on which you can write checks. ●Bonds, which cannot be used for transactions, but pay a positive interest rate,i. In reality there are many other assets than money, and in particular many types of bonds, each associated with a specific interest rate
The relation between the demand for money, nominal income and the interest rate O Md=SYl( (41) ●Mp/$Y=L() (4.2) o The demand for money increases in proportion to nominal income o The demand for money depends on the interest rate. This is captured by the function L( and the negative sign underneath An increase in the interest rate decreases the demand for money. 2003-6-29 3
2003-6-29 3 The relation between the demand for money, nominal income, and the interest rate Md =$YL(i) (4.1) (-) Md /$Y=L(i) (4.2) ⚫ The demand for money increases in proportion to nominal income. ⚫ The demand for money depends on the interest rate. This is captured by the function L(i) and the negative sign underneath: An increase in the interest rate decreases the demand for money
The Demand for Money M(for SY'>SY) M (for nominal income SY)
The Demand for Money i Md1(for $Y'>$Y) Md (for nominal income $Y) M M
4-2:The Determination of the Interest Rate: I Money Demand, Money Supply, and the Equilibrium Interest Rate S Monetary Policy and Open Market Operations 2003-6-29 5
2003-6-29 5 4-2:The Determination of the Interest Rate:Ⅰ Money Demand, Money Supply, and the Equilibrium Interest Rate Monetary Policy and Open Market Operations
The lm relation e Equilibrium in financial market requires that money supply be equal to money demand, that Ms=/MdUsing equation (4.1) for money demand, the equilibrium condition is Money supply Money demand M=SYLO This equation tells us that the interest rate must be such that people are willing to hold an amount of money equal to the existing money supply. This equilibrium relation is called the LM relation 2003-6-29 6
2003-6-29 6 The LM Relation Equilibrium in financial market requires that money supply be equal to money demand, that Ms= Md .Using equation (4.1) for money demand, the equilibrium condition is Money supply = Money demand M = $YL(I) ⚫ This equation tells us that the interest rate must be such that people are willing to hold an amount of money equal to the existing money supply. This equilibrium relation is called the LM relation
The determination of the nterest rate Money supply=money demand M=SYL(i M
The determination of the Interest Rate Money supply=Money demand M =$YL(i) i Ms i A Md M
The Effects nominal ncome on the nterest rate ($Y>$Y) M
The Effects Nominal Income on the Interest Rate i Ms i' A' M d' ($Y'>$Y) i A Md M
The Effects of an increase in the Money Supply on the Interest Rate
The Effects of an Increase in the Money Supply on the Interest Rate Ms Ms' i A i' A' Md M M
Monetary Policy and Open Market Operations The interest rate is determined by the equality of the supply of money and the demand for money By changing the supply of money, the central bank can affect the interest rate The central bank change the supply of money though open market operations, which are purchases or sales of bonds for money e Open market operations in which the central bank increases the money supply by buying bonds lead to an increase in the price of bonds-equivalently, a decrease in the interest rate e Open market operations in which the central bank decreases the money supply by selling bonds lead to an decrease in the price of bonds-equivalently, a increase in the interest rate 2003-6-29 10
2003-6-29 10 Monetary Policy and Open Market Operations The interest rate is determined by the equality of the supply of money and the demand for money. By changing the supply of money, the central bank can affect the interest rate. The central bank change the supply of money though open market operations, which are purchases or sales of bonds for money Open market operations in which the central bank increases the money supply by buying bonds lead to an increase in the price of bonds—equivalently, a decrease in the interest rate. Open market operations in which the central bank decreases the money supply by selling bonds lead to an decrease in the price of bonds—equivalently, a increase in the interest rate
