Monetary Policy and AD/AS

Monetary Policy and AD/ASChapter 20Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r2r1Md1 Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The graphic representation of the effect of changes in monetary policy and money demand on interest rate. Md2218Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r2M d2r1M d1Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.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.

318Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r1M d1Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Money is defined as M1-spending money418Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r2M d2r1M d1Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.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.

518Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r2M d2r1M d1Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.The money demand is the quantity of money the public is willing to hold (not save) as cash or checking deposits.618Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

r2r1Md1 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.Md2Money 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).718Equilibrium in the Money Market...Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupply

Equilibrium interest rateHarcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.MD2Interest rate 2Transaction 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.818