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The Money Market

The Money Market. The Money Market. The market where the Fed and the users of money interact thus determining the nominal interest rate (i%). Money Demand (MD) comes from households, firms, government and the foreign sector. The Money Supply (MS) is determined only by the Federal Reserve.

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The Money Market

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  1. The Money Market

  2. The Money Market • The market where the Fed and the users of money interact thus determining the nominal interest rate (i%). • Money Demand (MD) comes from households, firms, government and the foreign sector. • The Money Supply (MS) is determined only by the Federal Reserve.

  3. Money Demand • Transaction Demand – demand for money as a medium of exchange (independent of the interest rate). • Asset Demand – demand for money as a store of value (dependent on the interest rate). • Total Money Demand – (MD) is downward sloping because at high interest rates people are less inclined to hold money and more inclined to hold stocks & bonds. At lower interest rates people sacrifice less when they hold money.

  4. Money Supply • The money supply is determined by the Federal Reserve because the Fed has monopoly control over the supply of money.

  5. The Money Market i% MS i MD Q QM The equilibrium of MS & MD determines the nominal interest rate (i%). MD is downward sloping because the nominal interest rate is the opportunity cost of holding money. MS is vertical because it is independent of the interest rate.

  6. Changes in Money Demand • Money Demand is dependent on both the Price Level and Real GDP which together comprise the Nominal GDP • Nominal GDP↑ .: MD .: i%↑ • Nominal GDP↓ .: MD .: i%↓

  7. Changes in Money Demand DETERMINANTS • PL = higher prices increase MD, lower prices decrease MD • GDPr = increase in GDPr (total quantity of goods and services produced and sold in an economy) increase MD, Decrease GDPr decrease MD • Tech = advances in tech decrease MD • Banking Regulations = change bank policies can increase or decrease the MD

  8. Increase in Money Demand i% MS  i1  MD1  i MD Q QM MD .: i%↑

  9. Decrease in Money Demand i% MS  i  MD  i1 MD1 Q QM MD .: i%↓

  10. Changes in the Money Supply • Only the Fed determines the money supply • Expansionary Monetary Policy • MS .: i%↓ • Contractionary Monetary Policy • MS .: i%↑ • Fed can increase or decrease MS: • 1. Open-market operations: buying or selling bonds • 2. Lend money via discount window • 3. Change the reserve requirement

  11. Increase in Money Supply i% MS MS1  i   i1 MD Q Q1 QM MS .: i%↓

  12. Decrease in Money Supply i% MS1 MS  i1   i MD Q1 Q QM MS .: i%↑

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