1. 2. 3. C H A P T E R C H E C K L I S T. When you have completed your study of this chapter, you will be able to. Explain what determines the demand for money and how the demand for money and the supply of money determine the nominal interest rate.
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3C H A P T E R C H E C K L I S T
Explain how in the long run, the quantity of money determines the price level and money growth brings inflation.
The lower the nominal interest rate—the opportunity cost of holding money—the greater is the quantity of real money demanded.
1. Other things remaining the same, an increase in the nominal interest rate decreases the quantity of real money demanded.
2.A decrease in the nominal interest rate increases the quantity of real money demanded.
1. If the interest rate is 6 percent a year, the quantity of money held exceeds the quantity demanded. People buy bonds, the price of a bond rises, and the interest rate falls.
A decrease in the nominal interest rate increases the quantity of real money demanded.
2. If the interest rate is 4 percent a year, the quantity of money held is less than the quantity demanded. People sell bonds, the price of a bond falls, and the interest rate rises.13.1 MONEY AND THE INTEREST RATE
3. If the interest rate is 5 percent a year, the quantity of money held equals the quantity demanded and the money market is in equilibrium.
A rise in the nominal interest rate decreases the quantity of real money demanded.
This is right, but there are also other ways of thinking of what happens. Take increasing the money supply:
The Fed actually buysbonds, in an Open Market Operation, thereby making more reserves available to the banking system and specifically the Federal Funds Market.
Nothing having changed yet to change the demand for reserves in the Federal Funds Market, the Federal Funds rate falls, and the Federal Funds rate is the opportunity cost to commercial banks of additional reserves.
For that reason, the Federal Funds rate is the key short-term interest rate to which the financial system links other short term rates, so they all fall.
Yet another way to think of it is if the Fed buys bonds, the price of bonds will tend to rise, and when the price of bonds goes up, the interest rate goes down.Money and the Interest Rate
1. what happens. Take increasing the money supply:The demand for money depends on the price level.13.2 THE PRICE LEVEL AND INFLATION
2.The equilibrium nominal interest rate also depends on the price level.
3. The long-run equilibrium real interest rate …
4.Plusthe inflation rate determines . . .
5. Thelong-run equilibrium nominal interest rate.
6. The price level adjusts to 100 to achieve money market equilibrium at the long-run equilibrium interest rate.
1. what happens. Take increasing the money supply:The money supply increases by 2 percent from $1 trillion to $1.02 trillion and the supply curve shifts from MS0 to MS1.13.2 THE PRICE LEVEL AND INFLATION
2.In the short run, the interest rate falls to 4 percent a year.
3.In the long run, the price level rises by 2 percent from 100 to 102, the demand for money increases from MD0 to MD1, and the nominal interest rate returns to its long-run equilibrium level.
M V = PY
Remember, this is the definition of V; most transactions in the economy don’t buy final goods, so V is NOT the average number of times a year a dollar changes hands.
P = MVY.
Money growth + Velocity growth =
Inflation + Real GDP growth
Inflation Tax, Saving, and Investment