14 The Federal Reserve and Monetary Policy

money market The market for money in which the amount supplied and the amount demanded meet to determine the nominal interest rate. transaction demand for money The demand for money based on the desire to facilitate transactions. THE MONEY MARKET The Demand for Money INTEREST RATES AFFECT MONEY DEMAND

THE MONEY MARKET INTEREST RATES AFFECT MONEY DEMAND The Demand for Money  Demand for Money

THE MONEY MARKET The Demand for Money THE PRICE LEVEL AND GDP AFFECT MONEY DEMAND  Shifting the Demand for Money

THE MONEY MARKET The Demand for Money OTHER COMPONENTS OF MONEY DEMAND liquidity demand for money The demand for money that represents the needs and desires individuals and firms have to make transactions on short notice without incurring excessive costs. speculative demand for money The demand for money that arises because holding money over short periods is less risky than holding stocks or bonds.

open market operations The purchase or sale of U.S. government securities by the Fed. HOW THE FEDERAL RESERVE CAN CHANGE THE MONEY SUPPLY 1. Open Market Operations open market purchases The Fed’s purchase of government bonds from the private sector. open market sales The Fed’s sale of government bonds to the private sector. federal funds market The market in which banks borrow and lend reserves to and from one another. federal funds rate The interest rate on reserves that banks lend each other.

discount rate The interest rate at which banks can borrow from the Fed. HOW THE FEDERAL RESERVE CAN CHANGE THE MONEY SUPPLY Other Tools of the Fed 2. CHANGING RESERVE REQUIREMENTS 3. CHANGING THE DISCOUNT RATE required reserves The specific fraction of their deposits that banks are required by law to hold as reserves.

HOW INTEREST RATES ARE DETERMINED: COMBINING THE DEMAND AND SUPPLY OF MONEY  Equilibrium in the Money Market

HOW INTEREST RATES ARE DETERMINED: COMBINING THE DEMAND AND SUPPLY OF MONEY  Federal Reserve and Interest Rates

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)  The Money Market and Investment Spending

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)  Monetary Policy and Interest Rates

12 HOW INTEREST RATES ARE DETERMINED: COMBINING THE DEMAND AND SUPPLY OF MONEY Real Interest Rate Quantity of Loanable Funds LF S LF D LF R  Equilibrium in the Loanable Funds Market

13 Real Interest Rate Quantity of Loanable Funds LF S LF D LF R INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)  The Loanable Funds Market and Investment Spending

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)  Money Supply and Aggregate Demand Price Level Output LRAS SRAS AD 1 0 PL 1 Y1Y1 AD Y PL

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)

Monetary Policy and International Trade exchange rate The rate at which currencies trade for one another in the market. depreciation of a currency A decrease in the value of a currency.

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP) Monetary Policy and International Trade appreciation of a currency An increase in the value of a currency.