Money Market Graph 2003
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Transcript of Money Market Graph 2003
The Money Market Graph and the 3 Policy Tools that Change the Money
Supply
Monetary Policy
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
This graph is known as THE MONEY MARKET GRAPHWhen the Federal Reserve conducts a Monetary Policy this Is the FIRST market that is affected.
Notice that the Money Supply (MS*) curve is VERTICAL
This is because the Quantity of Money in circulation is FIXED At any given time. This measure of the Quantity of Money is The M1 Money Supply
The M1 Money Supply is the MOST liquid form of The Money Supply (Cash, Checkable Deposits, Travelers Checks). IMPORTANT NOTE!!!When the Federal Reserve conducts a Monetary PolicyIt is changing, either INCREASING or DECREASING, The M1 Money Supply!!
The M1 Money Supply is the MOST liquid form of The Money Supply (Cash, Checkable Deposits, Travelers Checks). IMPORTANT NOTE!!!When the Federal Reserve conducts a Monetary PolicyIt is changing, either INCREASING or DECREASING, The M1 Money Supply!!
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
The Money Market graph is used to Illustrate SHORT-TERM Interest Rates.
SHORT-TERM interest rates are established , well, in The short-term, so Inflation (in terms of the interest Rate) is not a factor.
Hence, we call this Interest Rate the NOMINAL INTEREST RATE.
There are MANY short-term interest rates in the financial system, but we will be concerned with only one: The FEDERAL FUNDS RATE
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
The FEDERAL FUNDS RATE is ONE of TWO interest rates that the Federal Reserve has DIRECT control over. It is defined as the Interest Rate Banks charge EACH OTHER to BORROW money from EACH OTHER.
It is also know as the Overnight Lending Rate.
For our purposes, equate the Nominal Interest Rate with the Federal Funds Rate: When The Nominal Interest Rate changes so does the Federal Funds Rate.
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
1.Open Market Operations (OMO’s)1. Buy Bonds – Federal Reserve
buys (purchases) bonds on the open market. This INCREASES the Money Supply
i1
Qms1
The result of this OMO DECREASES the Nominal Interest Rate(Federal Funds Rate). Borrowing between banks is now Less expensive. More money in flowing into the financialSystem. This sends a POWERFUL signal to the financial System that the supply of money has INCREASED and they Should adjust their interest rates LOWER.
MS1
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
1.Open Market Operations (OMO’s)1. Sell Bonds – Federal Reserve
sells bonds on the open market. This DECREASES the Money Supply
i1
Q1
The result of this OMO INCREASES the Nominal Interest Rate(Federal Funds Rate). Borrowing between banks is now MORE expensive. More money in flowing OUT of the financialSystem. This sends a POWERFUL signal to the financial System that the supply of money has DECREASED and they Should adjust their interest rates HIGHER.
MS1
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
2.Change the DISCOUNT RATEThe Discount Rate is the Interest
Rate theFederal Reserve charges banks to
BORROWFROM the Federal Reserve.
i1
MS1
Qms1If the Federal Reserve DECREASES the DiscountRate then Banks will tend to BORROW MORE From the Federal Reserve. This money will Go into the banks EXCESS RESERVES to be loanedOut and the money supply will INCREASE.
THE NOMINAL INTEREST RATE WILL DECREASE
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
i1
Q1 If the Federal Reserve INCREASES the DiscountRate then Banks will tend to BORROW LESS From the Federal Reserve. This money will DECREASE the money in the banking systems EXCESS RESERVES . There will be LESS money toBe loaned out. The money supply will DECREASE
THE NOMINAL INTEREST RATE WILL INCREASE
If the Federal Reserve INCREASES the DiscountRate then Banks will tend to BORROW LESS From the Federal Reserve. This money will DECREASE the money in the banking systems EXCESS RESERVES . There will be LESS money toBe loaned out. The money supply will DECREASE
THE NOMINAL INTEREST RATE WILL INCREASE
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
2.Change the DISCOUNT RATEThe Discount Rate is the Interest
Rate theFederal Reserve charges banks to
BORROWFROM the Federal Reserve.
MS1
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
3. Change the Required Reserve Ratio The Required Reserve is the amount that banks are required to with-hold from EACH deposit they receive . Expressed as a percentage.
i1
Qms1 If the Federal Reserve DECREASES the Required Reserve Ratio then banks will have LESS in R.R. and MORE in EXCESS RESERVES. This money will go into the banks EXCESS RESERVES to be loaned out and the money supply will INCREASE.
THE NOMINAL INTEREST RATE WILL DECREASE
MS1
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money
i1
Q1
First we are going to examine what shifts the Money Supply Curve in the Money Market
ANY OF THE FOLLOWING MONETARY POLICIES CAN SHIFT THE MONEY SUPPLY CURVE:
3. Change the Required Reserve Ratio The Required Reserve is the amount that banks are required to with-hold from EACH deposit they receive . Expressed as a percentage.
If the Federal Reserve INCREASES the Required Reserve Ratio then banks will have MORE in R.R. and LESS in EXCESS RESERVES. This will DECREASE the money in EXCESS RESERVES to be loaned out and the money supply will DECREASE.
THE NOMINAL INTEREST RATE WILL INCREASE
MS1
Monetary Policy and the Money Market Graph
If the Economy is in a Recession the Federal Reserve would do the following to DECREASE the Nominal Interest Rates (Federal Funds Rate)BUY BONDS, DECREASE THE REQUIRED RESERVE RATIO,
DECREASE THE DISCOUNT RATEThese all serve to INCREASE the money supply in the banking
system
The Federal Reserve is pursuing an EXPANSIONARY MONETARY POLICY
DECREASING the Nominal Interest Rate sends a powerful signal to the bankingSystem that they should DECREASE their interest rates. This will encourage consumers to borrow money to buy houses, cars, other consumer goods, etc. It will encourage businesses to borrow money to buy or replace capital equipment, expand facilities, build new facilities, etc (thus ADDING to the Capital Stock It will DEPRECIATE the dollar in the FOREX, making EXPORTS LESS expensive for foreigners to buy.
REAL GDP WILL INCREASE
Monetary Policy and the Money Market Graph
If the Economy is experiencing Inflation the Federal Reserve would do the following to INCREASE the Nominal Interest Rates (Federal Funds Rate)SELL BONDS, INCREASE THE REQUIRED RESERVE
RATIO, INCREASE THE DISCOUNT RATEThese all serve to DECREASE the money supply in
the banking systemThe Federal Reserve is pursuing a CONTRACTIONARY MONETARY POLICY
INCREASING the Nominal Interest Rate sends a powerful signal to the bankingSystem that they should INCEASE their interest rates. This will DISCOURAGE consumers from borrowing money to buy houses, cars, other consumer goods, etc. It will DISCOURAGE Businesses from borrow money to buy or replace capital equipment, expand facilities, Build new facilities, etc (thus SUBTRACTING from the Capital Stock It will APPPRECIATE the dollar in the FOREX, making EXPORTS MORE expensive for foreigners to buy.
REAL GDP WILL DECREASE
Money Market
MS*
i*
Money Demand (MD*)
Q*ms
NominalInterestRate
Quantity of Money