the bank of canada and monetary policy
DESCRIPTION
The Bank of Canada and Monetary Policy. Chapter 14 Instructor Shan A. Garib, Fall 2012. 14.1 The Bank of Canada. A central bank is an institution that oversees and regulates the banking system and controls the monetary base. - PowerPoint PPT PresentationTRANSCRIPT
1
THE BANK OF CANADA AND MONETARY POLICY
Chapter 14 Instructor Shan A Garib Fall 2012
141 The Bank of Canada A central bank is an institution that oversees
and regulates the banking system and controls the monetary base
The BoC is a central bankmdashan institution that oversees and regulates the banking system and controls the monetary base
142 The Tools of Monetary Policy
bull The most important job of the BoC is to control the rate of growth of the money supply
bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is
open-market operations
How Open-Market Operations Work
bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills
notes certificates and bondsndash The Fed buys and sells securities that have
already been marketed by the Treasurybull The total value of all outstanding CAN government
securities is more than $10 trillion This is our national debt
ndash What open market operations consist of then is the buying and selling of chunks of the national debt
How the Fed Increases the Money Supply
The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100ReqRes - 10
ExcessRes+90
The multiplier would be 1010 X 90 million = 900 million loans to earn interest
RD redeposit BoC deposit
DD drawn down
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
141 The Bank of Canada A central bank is an institution that oversees
and regulates the banking system and controls the monetary base
The BoC is a central bankmdashan institution that oversees and regulates the banking system and controls the monetary base
142 The Tools of Monetary Policy
bull The most important job of the BoC is to control the rate of growth of the money supply
bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is
open-market operations
How Open-Market Operations Work
bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills
notes certificates and bondsndash The Fed buys and sells securities that have
already been marketed by the Treasurybull The total value of all outstanding CAN government
securities is more than $10 trillion This is our national debt
ndash What open market operations consist of then is the buying and selling of chunks of the national debt
How the Fed Increases the Money Supply
The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100ReqRes - 10
ExcessRes+90
The multiplier would be 1010 X 90 million = 900 million loans to earn interest
RD redeposit BoC deposit
DD drawn down
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
142 The Tools of Monetary Policy
bull The most important job of the BoC is to control the rate of growth of the money supply
bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is
open-market operations
How Open-Market Operations Work
bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills
notes certificates and bondsndash The Fed buys and sells securities that have
already been marketed by the Treasurybull The total value of all outstanding CAN government
securities is more than $10 trillion This is our national debt
ndash What open market operations consist of then is the buying and selling of chunks of the national debt
How the Fed Increases the Money Supply
The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100ReqRes - 10
ExcessRes+90
The multiplier would be 1010 X 90 million = 900 million loans to earn interest
RD redeposit BoC deposit
DD drawn down
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How Open-Market Operations Work
bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills
notes certificates and bondsndash The Fed buys and sells securities that have
already been marketed by the Treasurybull The total value of all outstanding CAN government
securities is more than $10 trillion This is our national debt
ndash What open market operations consist of then is the buying and selling of chunks of the national debt
How the Fed Increases the Money Supply
The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100ReqRes - 10
ExcessRes+90
The multiplier would be 1010 X 90 million = 900 million loans to earn interest
RD redeposit BoC deposit
DD drawn down
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100ReqRes - 10
ExcessRes+90
The multiplier would be 1010 X 90 million = 900 million loans to earn interest
RD redeposit BoC deposit
DD drawn down
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = Interest Paid
Price of Bond
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities
IR = $80
$1000= 8
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
Suppose this pushed the price of the bond up to $1200
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Increases the Money Supply
The Fed writes a check for say $100 million (this is money created out of nothing)
Securities Firm
DD + $100
Assume 10 RR
RD + $100RR - 10 ER + 90
When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate
IR = $80
$1000= 8
IR = $80
$1200= 667
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb
The money supply decreases
The CAN buys CAN Government Securities
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
How the Fed Decreases the Money Supply
The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)
Securities Firm
DD - $100
Assume 10 RR
RD - $100
When the Fed goes into the open market to sell securities bond prices fall and interest rates climb
IR = $80
$1000= 8
IR = $80
$1200= 667
The money decreases
The CAN buys CAN Government Securities
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC
bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate
bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from
each other because they may not like to call attention to the fact they are having to borrow reserve deposits
Borrowing Reserve Deposits
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Changing Reserve Requirements
bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Changing Reserve Requirements
bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is
simply too powerfulndash If the reserve requirement on demand deposits
were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves
bull This would drastically reduce the nationrsquos money supply
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Summary The Tools of Monetary Policy
bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Summary The Tools of Monetary Policy
bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements
bull This would be done only as a last resort
An Importa
nt Slid
e
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Tools of Monetary Policy
bull Changing the reserve requirement
bull Changing the discount rate
bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Reserve Requirement and the Money Supply
bull The Fed can increase or decrease the money supply by changing the reserve requirement
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Reserve Requirement and the Money Supply
bull If the Fed decreases the reserve requirement it expands the money supply
ndash Banks have more money to lend outndash The money multiplier increases
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Reserve Requirement and the Money Supply
bull If the Fed increases the reserve requirement it contracts the money supply
ndash Banks have less money to lend outndash The money multiplier decreases
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Changing the Discount Rate
bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves
bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Changing the Discount Rate
bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Changing the Discount Rate
bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed
bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
143 The Demand of Money
bull Foregone interest is the opportunity cost (price) of money people choose to hold
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Demand for Money
bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus
bull A portfolio decision is the choice of how (where) to hold idle funds
LO1
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Demand for Money
bull Although holding money provides little or no interest there are reasons for doing so
ndash Transactions demandndash Precautionary demandndash Speculative demand
LO1
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Demand for Money
bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases
bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies
LO1
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Demand for Money
bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities
LO1
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Why Hold Money
bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Why Hold money
bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Keynesian Motives for Holding Money
bull The transaction motivendash Individuals have day-to-day purchases for
which they pay in cash or by checkndash Individuals take care of their rent or
mortgage payment car payment monthly bills and major purchases by check
ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Keynesian Motives for Holding Money
bull The precautionary motivendash People will keep money on hand just in
case some unforeseen emergency arises
bull They do not actually expect to spend this money but they want to be ready if the need arises
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Keynesian Motives for Holding Money
bull The speculative motivendash When interest rates are very low you
donrsquot stand to lose much holding your assets in the form of money
ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise
bull You would be locked into very low rates
ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Four Influences on the Demand for Money
bull The price levelndash As the price level rises people need to hold
higher money balances to carry out day-to-day transactions
ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth
ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Four Influences on the Demand for Money
bull Incomendash The more you make the more you
spendndash The more you spend the more money
you need to hold as cash or in your checking account
ndash Therefore as income rises so does the demand for money balances
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Four Influences on the Demand for Money
bull Interest ratesndash The quantity of money demanded (held)
goes down as interest rates risebull The alternative to holding your assets in the
form of money is to hold them in some type of interest bearing paper
bull As interest rates rise these assets become more attractive than money balances
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Four Influences on the Demand for Money
bull Credit availabilityndash If you can get credit you donrsquot need to
hold so much moneybull The last three decades have seen a veritable
explosion in consumer credit in the form of credit cards and bank loans
bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Four Influences on the Demand for Money
bull Four generalizationsndash As interest rates rise people tend to
hold less moneyndash As the rate of inflation rises people
tend to hold more moneyndash As the level of income rises people
tend to hold more moneyndash As credit availability increases people
tend to hold less money
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
The Demand Schedule for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactionsdemand
ATransactions demand
20
10
100 200
Precautionarydemand
B Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1000
Speculativedemand
C Speculative demand
The Three Demands for Money
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Total Demand for Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
2000 400 600 800 1000 1200 1400 1600 1800
Total demandfor money
This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Total Demand for Money and the Supply of Money
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
Total demandfor money
M
72
2000 400 600 800 1000 1200 1400 1600 1800
The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)
Since at any given time the supply of money (M) is fixed it can be represented as a vertical line
As money supply increases interest rates fall and I incrases gtgt AD incrases
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
Liquidity Trap
bull The liquidity trap is the portion of the money-demand curve that is horizontal
bull People are willing to hold unlimited amounts of money at some (low) interest rate
LO2
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP
MsV = PY
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
The equation of exchange and thequantity theory
MSV = PY
1048707 MS = actual money balances held by nonbanking public
1048707 V = income velocity of money
The number of times on average per year each monetary unit is spent on final goods and services
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
Income Velocity of Money
1048707 The number of times per year the dollar is spent on final goods and services
equal to the nominal GDP divided bythe money supply
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
Income Velocity of Money
The equation of exchange and thequantity theory
MSV = PY
1048707 P = price level or price index1048707 Y = real GDP per year
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
The equation of exchange asan identity1048707 Total funds spent on final output MsV
equals total funds received PY
1048707 The value of goods purchased is equal to the value of goods sold
1048707 MsV = PY = nominal GDP
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level
The quantity theory of moneyand prices1048707 Assume
V is constantY is stable
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-
LO2
The quantity theory of moneyand prices
1048707 Increases in Ms must be matched by equal increases in the price level
- The Bank of Canada and Monetary Policy
- 141 The Bank of Canada
- 142 The Tools of Monetary Policy
- How Open-Market Operations Work
- How the Fed Increases the Money Supply
- Slide 6
- Slide 7
- Slide 8
- Slide 9
- Slide 10
- How the Fed Decreases the Money Supply
- Slide 12
- Borrowing Reserve Deposits
- Changing Reserve Requirements
- Slide 15
- Summary The Tools of Monetary Policy
- Slide 17
- Tools of Monetary Policy
- The Reserve Requirement and the Money Supply
- The Reserve Requirement and the Money Supply
- Slide 21
- Changing the Discount Rate
- Slide 23
- Changing the Discount Rate
- 143 The Demand of Money
- The Demand for Money
- Slide 27
- Slide 28
- Slide 29
- Why Hold Money
- Why Hold money
- The Keynesian Motives for Holding Money
- The Keynesian Motives for Holding Money
- Slide 34
- Four Influences on the Demand for Money
- Four Influences on the Demand for Money
- Slide 37
- Slide 38
- Slide 39
- The Demand Schedule for Money
- Total Demand for Money
- Total Demand for Money and the Supply of Money
- Liquidity Trap
- PowerPoint Presentation
- Slide 45
- Slide 46
- Slide 47
- Slide 48
- Slide 49
- Slide 50
-