Monetary Policy and AD/AS

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Presentation transcript:

Monetary Policy and AD/AS

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... The graphic representation of the effect of changes in monetary policy and money demand on interest rate. Interest Rate Quantity fixed by the Fed Money supply Money demand r1 Md1 Equilibrium interest rate r2 Md2 Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... The interest rate is a nominal rate. Monetary policy targets the Federal Funds rate (the rate banks charge each other for over-night loans). Changes in this rate indicate to the Fed the amount of excess reserves in the banking system. Interest Rate Quantity fixed by the Fed Money supply Money demand r1 M d 1 Equilibrium interest rate r2 M d 2 Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... Interest Rate Quantity fixed by the Fed Money supply Money demand r1 M d 1 Equilibrium interest rate Money is defined as M1-spending money Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... This is the quantity of money made available in the economy by the Federal Reserve Open Market Committee (FOMC). Interest rates do not affect the money supply. Interest Rate Quantity fixed by the Fed Money supply Money demand r1 M d 1 Equilibrium interest rate r2 M d 2 Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... Interest Rate Quantity fixed by the Fed Money supply Money demand The money demand is the quantity of money the public is willing to hold (not save) as cash or checking deposits. r1 M d 1 Equilibrium interest rate r2 M d 2 Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Money Demand consists of two parts: Asset demand (liquidity theory)- how much money the public wants to hold as a financial asset for spending purposes; this is determined by interest rates and moves demand along the curve. High interest rates discourage asset demand (we prefer to save not spend). Interest Rate Quantity fixed by the Fed Money supply Money demand r1 Md1 r2 Md2 Quantity of Money 18

Equilibrium in the Money Market... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Money Market... Transaction demand- how much money the public needs in order to buy available goods and services; this is determined by Nominal GDP and causes the curve to shift. Higher NGDP would shift the demand curve right. Another factor would be alternative means of spending such as credit card use. Higher use of credit cards would shift the curve down. Changes in money demand changes the interest rate. Interest Rate Quantity fixed by the Fed Money supply MD2 Interest rate 2 Money demand Equilibrium interest rate Quantity of Money 18