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    Chapter 11 Money Demand and The Equilibrium Interest Rate

    Uploaded by

    Ward Alajlouni

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd

    Chapter 11 Money Demand and The Equilibrium Interest Rate

    Uploaded by

    Ward Alajlouni
    9 views12 pages

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    Chapter 11 Money Demand and the Equilibrium Interest Rate

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    Copyright:

    © All Rights Reserved
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    9 views12 pages

    Chapter 11 Money Demand and The Equilibrium Interest Rate

    Uploaded by

    Ward Alajlouni

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 12

    Money Demand and

    the Equilibrium 11
    Interest Rate
    CHAPTER OUTLINE
    Interest Rates and Bond Prices
    The Demand for Money
    The Transaction Motive
    The Speculation Motive
    The Total Demand for Money
    The Effect of Nominal Income on the Demand for Money
    The Equilibrium Interest Rate
    Supply and Demand in the Money Market
    Changing the Money Supply to Affect the Interest Rate
    Increases in P • Y and Shifts in the Money Demand Curve
    Zero Interest Rate Bound

    Looking Ahead: The Federal Reserve and Monetary


    Policy
    Appendix A: The Various Interest Rates in the U.S.
    Economy
    Appendix B: The Demand for Money: A Numerical
    Example

    © 2014 Pearson Education,Inc. 3 of 25


    Interest Rates and Bond Prices
    Interest The fee that borrowers pay to lenders for the use of their funds.

    Firms and governments borrow funds by issuing bonds, and they pay
    interest to the lenders that purchase the bonds.
    Bonds are financial assets have the following Properties:
     It’s issued with a face value.
     It’s come with maturity date.
     Many bonds make coupon payments → specific amounts of money paid
    once or twice a year to Bondholder

    Interest rates and bond prices are inversely related. An increase in a


    bond’s price always means the interest rate on the bond (the yield to
    maturity) has fallen.
    © 2014 Pearson Education,Inc. 4 of 25
    The Demand for Money

     The demand for money is the part of financial assets that people

    want to hold in the form of money (which does not earn interest).

     When we speak of the demand for money, we are concerned with


    how much of your financial assets you want to hold in the form of
    money, which does not earn interest, versus how much you want to
    hold in interest-bearing securities such as bonds. Not How much
    income would you like to earn?

    **How much money to hold involves a trade-off between the liquidity of


    money and the interest income offered by other kinds of assets.

    © 2014 Pearson Education,Inc. 7 of 25


    Motives For Money Demand
    (1) Transactions motive:
     We assume that: There are mismatch between income and spending,
    because Spending occurs at times different from receiving the income.
     People hold money to buy things.
     There is a positive relationship between the quantity of money you carry for
    transaction reasons and the level of income or (trading)→ If nominal income
    (P.Y) Md for transactions & vice versa.
    (2) Speculative motive:
     People hold money with the hope to make capital gains. It’s negatively
    related to the interest rate.
     If the interest rate (r) the market price of the existing bonds
    people will buy bonds (demand for bonds ) with the hope to selling them
    when the interest rate falls in order to make capital gains money
    demand (Md )
    The Equilibrium Interest Rate

    We are now in a position to consider one of the key questions in


    macroeconomics: How is the interest rate determined in the economy?

    The point at which the quantity of money demanded equals the quantity of
    money supplied determines the equilibrium interest rate in the economy.

    At the equilibrium interest rate r* the demand for bonds


    by households and firms is equal to the supply.

    3 tools to control money supply from central bank:


    1- RRR
    2- Discount Rate
    3-Open market operation

    © 2014 Pearson Education,Inc. 18 of 25


    The Supply For Money

    Increase money supply so i can decrease The interest rate


    Decrease money supply so i can increase the rate
    The Equilibrium Interest Rate

    Money Demand (up) --> Bonds Supply (up) --> Interest Rate (up)
    To sum up

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