CONTEMPORARY ECONOMICS © Thomson South-Western

17.2 Monetary Policy in the Short Run

Explain the shape of the money demand curve. Explain how changes in the money supply

affect interest rates and real GDP in the short run.

Discuss the federal funds rate and why the Fed uses this rate to pursue monetary policy goals.

Objectives

CONTEMPORARY ECONOMICS © Thomson South-Western

17.2 Monetary Policy in the Short Run

money demandmoney supply federal funds market federal funds rate

Key Terms

17.2 Monetary Policy in the Short Run SLIDE

3

CONTEMPORARY ECONOMICS © Thomson South-Western

Money Demand

A medium of exchangeA store of valueThe cost of holding moneyMoney demand and interest rates

Money demand—the relationship between how much money people want to hold and the interest rate

17.2 Monetary Policy in the Short Run SLIDE

4

CONTEMPORARY ECONOMICS © Thomson South-Western

Demand for MoneyThe money demand

curve, Dm, slopes downward.

As the interest rate falls, so does the opportunity cost of holding money.

The quantity of money demanded increases.

Figure 17.2

17.2 Monetary Policy in the Short Run SLIDE

5

CONTEMPORARY ECONOMICS © Thomson South-Western

Money Supply and the Market Interest Rate

Money supply—the supply of money available in the economy at a particular time

Market interest rateAn increase in the money supplyEffect of lower interest ratesIncreasing interest rates

17.2 Monetary Policy in the Short Run SLIDE

6

CONTEMPORARY ECONOMICS © Thomson South-Western

Effect of an Increase in the Money Supply

Figure 17.3

17.2 Monetary Policy in the Short Run SLIDE

7

CONTEMPORARY ECONOMICS © Thomson South-Western

Ways to Expand the Money Supply

Purchasing U.S. government securitiesReducing the discount rateLowering the required reserve ratio

17.2 Monetary Policy in the Short Run SLIDE

8

CONTEMPORARY ECONOMICS © Thomson South-Western

Effects of a Lower Interest Rate

Figure 17.4

17.2 Monetary Policy in the Short Run SLIDE

9

CONTEMPORARY ECONOMICS © Thomson South-Western

Ways to Reduce the Money Supply

Selling U.S. government securitiesIncreasing the discount rateRaising the required reserve ratio

17.2 Monetary Policy in the Short Run SLIDE

10

CONTEMPORARY ECONOMICS © Thomson South-Western

The Federal Funds Rate

Federal funds marketFederal funds market—a market for overnight

lending and borrowing of reserves held by the Fed for banks

Federal funds rate—the interest rate banks charge one another to borrow reserves overnight; the Fed’s target interest rate

Aggressive rate cutsWhy target this rate?Recent history of federal funds rate

17.2 Monetary Policy in the Short Run SLIDE

11

CONTEMPORARY ECONOMICS © Thomson South-Western

Ups and Downs in the Federal Funds Rate Since 1996

Figure 17.5