[MACRO] 07 - Money Demand, the Equilibrium Interes Rate and Monetary Policy Flashcards
3 Tools of Monetary Policy
1) Reserve Ratio
2) Discount Rate
3) Open Market Operation
Definition: Reserve Rate (RR)
The amount of money that is kept in reserve of the banks (be it central or commercial).
Increase RR –> Money Supply Decreases
Decrease RR –> Money Supply Increases
Definition: Discount Rate (DR)
Discount Rate is the interest rate for the type of credit that a commercial bank asks for from the central bank if it cannot fulfil its reserves. The discount rate is way above the normal interest rate, which is why the discount rate hardly comes into play and when it does its only for a very short time.
Definition: Open Market Operations (OMO)
For example when households buy bonds of a country. This is a means of decreasing inflation rates, as purchasing power is decreased if more people purchase bonds. As bonds do not create demand, this regulates the amount of money in the economy.
Definition: Expansionary Monetary Policy
Decrease in RR, DR and buys OMO. This leads to an increase in money supply.
Definition: Contractionary Monetary Policy
Increase in RR, DR and sells OMO. This leads to a decrease in money supply.
Definition: Money Multiplier
1/RR
Definition: Money Demand
The amount of a person’s money that they would like to keep in non-interest bearing form.
Motives of Money Demand (3)
1) Demand of goods and services
2) Security and unpredictable expenditure
3) Money demand for speculation
Determinants of Money Demand (3)
1) Interest Rates
2) Prices
3) Income
Definition: Speculation Motive
One reason for holding bonds instead of money, is because the market value of interest-bearing bonds is inversely related to the interest rate, investors may wish to hold bonds when interest rates are high with the hope of selling them when interest rates fall.
