1. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2Monetary Policy in the Short Run  Explain the shape of the money demand curve.  Explain how changes in the money supply affect interest rates and real GDP in the short run.  Discuss the federal funds rate and why the Fed uses this rate to pursue monetary policy goals. Objectives

2. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2Monetary Policy in the Short Run  money demand  money supply  federal funds market  federal funds rate Key Terms

3. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 3 Money Demand A medium of exchange A store of value The cost of holding money Money demand and interest rates Money demand—the relationship between how much money people want to hold and the interest rate

4. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 4 Demand for Money The money demand curve, Dm, slopes downward. As the interest rate falls, so does the opportunity cost of holding money. The quantity of money demanded increases. Figure 17.2

5. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 5 Money Supply and the Market Interest Rate Money supply—the supply of money available in the economy at a particular time Market interest rate An increase in the money supply Effect of lower interest rates Increasing interest rates

6. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 6 Effect of an Increase in the Money Supply Figure 17.3

7. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 7 Ways to Expand the Money Supply Purchasing U.S. government securities Reducing the discount rate Lowering the required reserve ratio

8. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 8 Effects of a Lower Interest Rate Figure 17.4

9. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 9 Ways to Reduce the Money Supply Selling U.S. government securities Increasing the discount rate Raising the required reserve ratio

10. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 10 The Federal Funds Rate Federal funds market Federal funds market—a market for overnight lending and borrowing of reserves held by the Fed for banks Federal funds rate—the interest rate banks charge one another to borrow reserves overnight; the Fed’s target interest rate Aggressive rate cuts Why target this rate? Recent history of federal funds rate

11. CONTEMPORARY ECONOMICS© Thomson South-Western 17.2 Monetary Policy in the Short Run SLIDE 11 Ups and Downs in the Federal Funds Rate Since 1996 Figure 17.5