Lecture 3: Financial Market Flashcards
(24 cards)
What are the three main segments of the financial market?
- Money Market (short-term money supply and demand)
- Securities Market (credit market – securitized claims)
- Capital Market (medium and long-term capital)
What two types of assets are assumed in the financial market model?
Money (liquid, no interest) and Bonds (non-liquid, yield interest i)
Why do individuals choose between holding money and bonds?
To manage liquidity vs. return; money is liquid, bonds yield interest.
What is the formula for money demand?
Money Demand = PY * L(i)
How does interest rate affect money demand?
As interest rate ↑ → money demand ↓ (negative correlation)
How does nominal income (PY) affect money demand?
Nominal income ↑ → money demand ↑ proportionally
What does L(i) represent?
Liquidity preference = Money Holding / National Income; decreases with higher i
What are the main sources of money creation?
Central banks (cash/reserves) and commercial banks (demand deposits)
Name 4 instruments of central bank monetary policy.
- Open market operations
- Forward guidance
- Reserve requirements
- Helicopter money
What happens during expansionary monetary policy?
Central bank buys bonds → money supply ↑ → interest rate ↓
How is equilibrium in the money market defined?
When money demand = money supply
How does an increase in money supply affect interest rate?
Money supply ↑ → shifts curve right → interest rate ↓
Under interest rate control, how does the central bank act?
Sets i and provides as much money as needed to maintain i.
Under money supply control, what happens when income increases?
Interest rate ↑ to maintain constant money supply (upward-sloping LM curve)
What is the difference between M and H?
M = money supply; H = central bank money (monetary base)
Why do banks hold reserves? (3 reasons)
- Daily transactions
- Debts to other banks
- Legal reserve requirements
What is the reserve ratio (0)?
Reserves held per unit of checkable deposit
What are the 3 tools to control money supply?
- Base rate
- Deposit rate
- Minimum reserve rate
How does central bank influence money supply indirectly?
By affecting commercial banks’ lending capacity and deposit creation
What is the relationship between bond prices and interest rates?
Inverse: Bond price ↑ → Interest rate ↓ and vice versa
What does the LM curve represent?
Equilibrium in the money market
What is the condition for LM curve equilibrium?
M/P = Y * L(i) (real money supply = real money demand)
What shape is the LM curve under interest rate control?
Horizontal (flat)
What happens above and below the LM curve? And what does it mean if we’re on the LM curve?
Above: excess money supply
Below: excess money demand
On the LM Curve: Equilibrium on the money market
