Money and Interest Rates Chapter 14-2

Ha..Ha..Ha.. A caveman points to two of his hairy relatives carrying clubs over their shoulders and says: “OK—you hunt, you gather, and I’ll fine tune the economy.”

Avoid the Confusion! “From now on we will drop the word nominal with the understanding that MD and MS represent nominal quantities.”  Page 350: “From now on we will drop the word nominal with the understanding that MD and MS represent nominal quantities.”  Nominal- a measure or quantity that has not been adjusted for changes in prices over time.

Equilibrium Interest Rate According to the liquidity preference model of the interest rate, the interest rate is determined by the supply and demand for money. The money supply curve shows how the nominal quantity of money supplied varies with the interest rate.

Equilibrium in the Money Market

The Effect of an Increase in the Money Supply on the Interest Rate

Setting the Federal Funds Rate Setting the Federal Funds Rate - Pushing the Interest Rate Down to the Target Rate The target federal funds rate is the Federal Reserve’s desired federal funds rate.

Setting the Federal Funds Rate Setting the Federal Funds Rate - Pushing the Interest Rate Up to the Target Rate

The Fed Funds Rate as an Operating Target  The Fed looks at the Federal funds rate to determine whether monetary policy is tight or loose.

The Fed Funds Rate as a Target  If the Federal funds rate is above the Fed’s target range, it buys bonds.  This increases reserves and lowers the Federal funds rate.

The Fed Funds Rate as a Target  If the Federal funds rate is below the Fed’s target range, it sells bonds.  This decreases reserves and raises the Federal funds rate.

The Complex Nature of Monetary Policy  The Fed watches other data to see if it is on track.  Other data include consumer confidence, stock prices, interest rate spreads, housing starts, and a host of others.

The Fed Moves Interest Rates

PITFALLS Page 351  Interest Rates are determined by Supply and Demand for Money!  Markets set the interest rate  1980s Target Money Supply  So Interest rate fluctuated  Today Target Fed Fund Rate  Money supply fluctuates