Lecture 5 Flashcards
What does the theory liquidity preference say?
the interest rates adjusts to balance the supply and demand for money
According to Keynes’ theory of liquidity preference, the equilibrium money _______ and money _________ determines the _________ interest rate
supply
demand
nominal
According to Keynes’ theory of liquidity preference, MS and MD are what shape and why?
MD is downward sloping because the nominal interest rate is the opportunity cost of holding money and MS is vertical because it is independent of the interest rate
What is nominal interest rate defined as according to Keynes’ theory of liquidity preference?
it is the opportunity cost of holding money
What four things can affect the demand for money?
- the level of income
- interest rates
- inflation
- uncertainty about the future
What are three motives for demanding money?
- the transactions motive
- the precautionary motive
- the speculative motive
What is the transactions motive for demanding money?
What happens to the transactions demand for money as income or GDP increases?
Demand of money arises from the fact that most transactions involve an exchange of money so it is necessary to have money available for transactions, money will be demanded. Hence, as income or GDP rises, the transactions demand for money also rises
What is the precautionary motive for demanding money?
People often demand money as precaution against an uncertain future such as unexpected expenses which often require immediate payment (the need to have money available in such situations gives rise to the precautionary motive for demanding money
What is the speculative motive for demanding money?
- money is one store value, this is an __________. Demand for an ______ depends on its rate of _________ and its _______ cost. Typically, money holdings provide ____ rate of ______ and often depreciate due to ________
- the opportunity cost of holding money is the _______ rate that can be earned by lending or ________ one’s money _________.
- the speculative motive for demanding money arises in situations where holding money is perceived to be __________ risky than the alternative of lending the money or investing it in some other asset
- money is one store value, this is an asset. Demand for an asset depends on its rate of return and its opportunity cost. Typically, money holdings provide no rate of return and often depreciate due to inflation
- the opportunity cost of holdings money is the interest rate that can be earned by lending or investing one’s money holdings.
- the speculative motive for demanding money arises in situations where holding money is perceived to be less risky than the alternative of lending the money or investing it in some other asset
A shift in the money demand reflects a change in what?
monetary policy
What happens to the demand for money (and therefore interest rates) when nominal GDP increases?
* nominal GDP increasing is caused by a rise in economic growth, rising prices or both
Money demand increases so it shifts to the right meaning that interest rates (which are on the y axis of the graph) also increase
What happens to the demand for money (and therefore interest rates) which nominal GDP decrease?
* nominal GDP decreasing is caused by fall in economic growth, falling prices or both
Money demand decreases so it shifts to the left meaning that interest rates (which are on the y axis of the graph) also decrease
What are the three main mechanisms for influencing the money supply?
- open market operations
- reserve ratio requirements
- discount rates
What are open market operations?
This is when the Reserve bank gives out a piece of paper with a promise to pay back the money that you give them in the future. You can take that bit of paper back to the bank later and they give you back your funds. In other words, the reserve bank can buy and sell securities to increase/decrease funds in the market.
What is the reserve requirement ratio?
The portion of deposits that banks must have on hand as cash and this amount is set by the central bank.
What does increasing the required reserve ratio do to the money supply?
Increasing the required reserve ratio increases the amount of cash that banks are required to hold in reserves which decreases the availability for loans and therefore decreases the money supply and works to decrease inflation. This is the opposite for decreasing the required reserve ratio
What is the discount rate?
The interest rate charged to commercial banks for loans received from the central bank.
What is expansionary monetary policy and what does it do to the money supply?
this is when the central bank uses monetary policy in such as way as to cause an increase in the supply of money
this shifts it to the right on the diagram
What does contractionary monetary policy and what does it do to the money supply?
this is when the central bank uses monetary policy in such as way as to cause a decrease in the supply of money
this shift it to the left on the diagram
Why is the central bank’s control of money not be very precise?
Because it can not control household preferences for cash or the reserve ratio held by banks
An increase in household’s preference for cash will ___________ deposits at the bank and ultimately __________ decrease the money supply
decrease
decrease
An increase in bank’s reserve ratio will _______ the money supply
decrease
Due to problems in controlling the money supply, the RBNZ targets the interest rate using the OCR rather than the money supply. True or false?
true
When the RBNZ lowers the OCR, what happens to reserves? Why is this? How is this seen in the general money market?
They increase because settlement cash with the RBNZ decrease
this can be seen as a vertical shift to the right in MS
