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.

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Presentation transcript:

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 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.

THE MONEY MARKET INTEREST RATES AFFECT THE QUANTITY OF MONEY DEMANDED The Demand for Money  Demand for Money

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

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 3. CHANGING RESERVE REQUIREMENTS 2. CHANGING THE DISCOUNT RATE reserve requirement The specific fraction of their deposits that banks are required by law to hold as reserves. Monetary Policy Explained in Detail

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

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.

THE LOANABLE FUNDS MARKET What is the market for loanable funds? loanable funds market The loanable funds market is a conceptual market where savers (suppliers) and borrowers (demanders) are able to establish an equilibrium quantity and price (interest rate). How does the market for loanable funds work? Savings and investment are affected primarily by the interest rate. For savings, interest rate is directly related and creates a positive slope between the two, because as interest rates increase, saving becomes more lucrative, so people save more. For investment, interest rate is indirectly related and creates a negative slope, because the cost of a loan increases as interest rates increase.

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

HOW INTEREST RATES ARE DETERMINED: COMBINING THE DEMAND AND SUPPLY OF LOANABLE FUNDS Supply of Loanable Funds Demand for Loanable Funds The supply of loanable funds comes from individuals who have excess cash that they wish to earn a return on (savers). The demand for loanable funds comes from anyone who has the need for additional money for some intended purpose. The demand is comprised of households (C), firms (I), and government (G).

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

INTEREST RATES AND HOW THEY CHANGE INVESTMENT AND OUTPUT (GDP)  How an increase in the supply of LF affects AD Price Level Output LRAS SRAS AD 1 0 PL 1 Y1Y1 AD Y PL