Chapter 14 Money. Interest Rates, and Exchange rates
Chapter 14 ▪ Money,Interest Rates,and Exchange rates
Chapter organization Introduction Money Defined: A Brief Review The Demand for Money by Individuals ggregate Money Demand The Equilibrium Interest Rate: The Interaction of Money Supply and demand Copyright C 2003 Pearson Education, Inc Slide 14-2
Copyright © 2003 Pearson Education, Inc. Slide 14-2 ▪ Introduction ▪ Money Defined: A Brief Review ▪ The Demand for Money by Individuals ▪ Aggregate Money Demand ▪ The Equilibrium Interest Rate: The Interaction of Money Supply and Demand Chapter Organization
Chapter organization The Money Supply and the exchange rate in the Short run Money, the Price Level, and the Exchange Rate in the ong Run Inflation and Exchange Rate dynamics Summary Copyright C 2003 Pearson Education, Inc Slide 14-3
Copyright © 2003 Pearson Education, Inc. Slide 14-3 ▪ The Money Supply and the Exchange Rate in the Short Run ▪ Money, the Price Level, and the Exchange Rate in the Long Run ▪ Inflation and Exchange Rate Dynamics ▪ Summary Chapter Organization
Introduction Factors that affect a country' s money supply or demand are among the most powerful determinants of its currency's exchange rate against foreign currencies a This chapter combines the foreign-exchange market with the money market to determine the exchange rate in the short run It analyzes the long-term effects of monetary changes on output prices and expected future exchange rates Copyright C 2003 Pearson Education, Inc Slide 14-4
Copyright © 2003 Pearson Education, Inc. Slide 14-4 Introduction ▪ Factors that affect a country’s money supply or demand are among the most powerful determinants of its currency’s exchange rate against foreign currencies. ▪ This chapter combines the foreign-exchange market with the money market to determine the exchange rate in the short run. • It analyzes the long-term effects of monetary changes on output prices and expected future exchange rates
Money Defined: A Brief Review Money as a Medium of Exchange a generally accepted means of payment a money as a Unit of Account a widely recognized measure of value Money as a Store of value A transfer of purchasing power from the present into the future Copyright C 2003 Pearson Education, Inc Slide 14-5
Copyright © 2003 Pearson Education, Inc. Slide 14-5 Money Defined: A Brief Review ▪ Money as a Medium of Exchange • A generally accepted means of payment ▪ Money as a Unit of Account • A widely recognized measure of value ▪ Money as a Store of Value • A transfer of purchasing power from the present into the future
Money Defined: A Brief Review What Is Money Assets widely used and accepted as a means of payment Money is very liquid, but pays little or no return All other assets are less liquid but pay higher return Money supply (s) Ms- Currency+ Checkable Deposits Copyright C 2003 Pearson Education, Inc Slide 14-6
Copyright © 2003 Pearson Education, Inc. Slide 14-6 ▪ What Is Money? • Assets widely used and accepted as a means of payment. • Money is very liquid, but pays little or no return. – All other assets are less liquid but pay higher return. • Money Supply (Ms ) Ms = Currency + Checkable Deposits Money Defined: A Brief Review
Money Defined: A Brief Review How the Money Supply Is Determined An economys money supply is controlled by its central bank The central bank Directly regulates the amount of currency in existence Indirectly controls the amount of checking deposits issued by private banks Copyright C 2003 Pearson Education, Inc Slide 14-7
Copyright © 2003 Pearson Education, Inc. Slide 14-7 ▪ How the Money Supply Is Determined • An economy’s money supply is controlled by its central bank. – The central bank: – Directly regulates the amount of currency in existence – Indirectly controls the amount of checking deposits issued by private banks Money Defined: A Brief Review
The Demand for Money by Individuals Three factors influence money demand ● Expected return Risk ° Liquidity Expected Return The interest rate measures the opportunity cost of holding money rather than interest-bearing bonds A rise in the interest rate raises the cost of holding money and causes money demand to fall Copyright C 2003 Pearson Education, Inc Slide 14-8
Copyright © 2003 Pearson Education, Inc. Slide 14-8 ▪ Three factors influence money demand: • Expected return • Risk • Liquidity ▪ Expected Return • The interest rate measures the opportunity cost of holding money rather than interest-bearing bonds. – A rise in the interest rate raises the cost of holding money and causes money demand to fall. The Demand for Money by Individuals
The Demand for Money by Individuals Risk Holding money is risky An unexpected increase in the prices of goods and services could reduce the value of money in terms of the commodities consumed Changes in the risk of holding money need not cause individuals to reduce their demand for money any change in the riskiness of money causes an equal change in the riskiness of bonds Copyright C 2003 Pearson Education, Inc Slide 14-9
Copyright © 2003 Pearson Education, Inc. Slide 14-9 ▪ Risk • Holding money is risky. – An unexpected increase in the prices of goods and services could reduce the value of money in terms of the commodities consumed. • Changes in the risk of holding money need not cause individuals to reduce their demand for money. – Any change in the riskiness of money causes an equal change in the riskiness of bonds. The Demand for Money by Individuals
The Demand for Money by Individuals nudity The main benefit of holding money comes from its liquidity. Households and firms hold money because it is the easiest way of financing their everyday purchases A rise in the average value of transactions carried out by a household or firm causes its demand for money to rise Copyright C 2003 Pearson Education, Inc Slide 14-10
Copyright © 2003 Pearson Education, Inc. Slide 14-10 ▪ Liquidity • The main benefit of holding money comes from its liquidity. – Households and firms hold money because it is the easiest way of financing their everyday purchases. • A rise in the average value of transactions carried out by a household or firm causes its demand for money to rise. The Demand for Money by Individuals