lecture 2 Flashcards
(17 cards)
studying the market in isolation assumptions
closed economy, money and bonds are the only available financial assets, bonds pay interest but cannot be used for transactions, money does not pay interest, P and Y are fixed.
money
can be spent and used for transactions, pays no interest
liquidity
measures the ease that an asset can be turned into cash without a loss of value. Money and short term US treasury securities are high liquidity, bonds and corporate equity are less liquid.
Bonds
interest earning long term assets and are less liquid. cannot be used for transactions
proportion of money and bonds
depends on level of transactions and the interest rate on bonds
interest rate
the cost of holding liquid assets and the opportunity cost forgone by not loaning out the money
Md = Y.L(i)
the demand for money. affected by an increase in nominal income or an increase in price level.
Ms = Ms
supply of money. fixed exogenously by the central bank.
ways central bank can increase money supply
Lowering the reserve ratio (portion of deposits banks must hold at central bank), lowering the discount rate (rate at which banks can borrow from central bank), purchasing government securities.
open market operations
methods the central banks use to change the money stock. Can either be expansionary (increasing supply) or contractionary (decreasing supply)
yield / price of bond = i (interest)
formula to find interest rate of bond
price of bond = 100/1+i
formula to find price of bond
money market equilibrium
money supply = money demand. Ms = Y.L(i)
called the LM relation.
effects of increase in money demand
price level increase or income increase leads to increase in Md, increase in income rate
effects of increase in money supply
decrease in interest rate
flaw of simplified model
does not include cheques and private banks
demand for central bank money
equal to the sum of the demand for currency and the demand for reserves
