interest rate and monetary policy pertemuan 11 matakuliah: j0594-teori ekonomi tahun: 2009
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INTEREST RATE AND MONETARY POLICY
Pertemuan 11
Matakuliah : J0594-Teori EkonomiTahun : 2009
Bina Nusantara University 3
Interest Rates
Defined as the Price Paid for the Use of Money
Demand for MoneyTransactions Demand, D1
Asset Demand, D2
Total Money Demand, Dm
…Graphically
Bina Nusantara University 4
Interest RatesR
ate
of
Inte
res
t, I
pe
rce
nt
10
7.5
5
2.5
0 50 100 150 200 50 100 150 200 50 100 150 200 250 300
Amount of MoneyDemanded
(Billions of Dollars)
Amount of MoneyDemanded
(Billions of Dollars)
Amount of MoneyDemanded and Supplied
(Billions of Dollars)
=+
(a)TransactionsDemand forMoney, Dt
(b)Asset
Demand forMoney, Da
(c)Total
Demand forMoney, Dm
And Supply
Dt Dm
Sm
5
Da
Demand for Money and the Money Market
Bina Nusantara University 5
Interest Rates
• Equilibrium Interest Rate• Interest Rates and Bond Prices
– Bond Prices Fall When Interest Rates Rise
– Bond Prices Rise When Interest Rates Fall
– Inverse Relationship Between Interest Rates and Bond Prices
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Tools of Monetary Policy
• Open Market Operations– Buying Securities
•From Commercial Banks•From the Public
– Selling Securities•To Commercial Banks•To the Public
• When the Fed Sells Securities, Commercial Bank Reserves are Reduced
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Tools of Monetary Policy
New Reserves$1000
$5000Bank System Lending
Total Increase in the Money Supply, ($5,000)
Fed Buys $1,000 Bond from a Commercial Bank
$1000Excess
Reserves
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Tools of Monetary Policy
Check is DepositedNew Reserves
$1000
Total Increase in the Money Supply, ($5000)
Fed Buys $1,000 Bond from the Public
$200RequiredReserves
$800Excess
Reserves
$1000Initial
CheckableDeposit
$4000Bank System Lending
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Tools of Monetary Policy
• The Reserve Ratio– Raising the Reserve Ratio– Lowering the Reserve Ratio
• The Discount Rate– Borrowing from the Fed by Banks
Increases Reserves and Enhances Lending Ability
• Relative Importance of Each
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Monetary Policy
10
8
6
0
Amount of Investment, I(Billions of Dollars)
Pri
ce
Le
ve
l
Real Domestic Product, GDP(Billions of Dollars)
Q1 Qf Q3$125 $150 $175
$25P2
P3
Sm1 Sm2 Sm3
DmID
AD1
I=$15
AD2
I=$20
AD3
I=$25
(a)The MarketFor Money
(b)Investment
Demand
(c)Equilibrium Real
GDP and thePrice Level
AS
Ra
te o
f In
tere
st,
i (
Pe
rce
nt)
Amount of MoneyDemanded and Supplied
(Billions of Dollars)
$15 $20 $25
Monetary Policy and Equilibrium GDP
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Monetary Policy
• Cause-Effect Chain• Market for Money• Investment• Equilibrium GDP• Effects of an Expansionary Monetary
Policy• Effects of a Restrictive Monetary
Policy
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Monetary PolicyExpansionary Monetary Policy
Problem: Unemployment and Recession
Fed Buys Bonds, Lowers ReserveRatio, or Lowers the Discount Rate
Excess Reserves Increase
Federal Funds Rate Falls
Money Supply Rises
Interest Rate Falls
Investment Spending Increases
Aggregate Demand Increases
Real GDP Rises
CA
US
E-E
FF
EC
T C
HA
IN
Bina Nusantara University 13
Monetary PolicyRestrictive Monetary Policy
Problem: Inflation
Fed Sells Bonds, Increases ReserveRatio, or Increases the Discount Rate
Excess Reserves Decrease
Federal Funds Rate Rises
Money Supply Falls
Interest Rate Rises
Investment Spending Decreases
Aggregate Demand Decreases
Inflation Declines
CA
US
E-E
FF
EC
T C
HA
IN