Matakuliah Tahun : J0594-Teori Ekonomi : 2009 INTEREST RATE AND MONETARY POLICY Pertemuan 11 Interest Rates Defined as the Price Paid for the Use of Money Demand for Money Transactions Demand, D1 Asset Demand, D2 Total Money Demand, Dm …Graphically Bina Nusantara University 3 Interest Rates Demand for Money and the Money Market Rate of Interest, I percent (a) Transactions Demand for Money, Dt (b) Asset Demand for Money, Da (c) Total Demand for Money, Dm And Supply 10 Sm 7.5 =5 + 5 2.5 Dt 50 Bina Nusantara University 100 Dm Da 0 150 200 Amount of Money Demanded (Billions of Dollars) 50 100 150 200 Amount of Money Demanded (Billions of Dollars) 50 100 150 200 250 300 Amount of Money Demanded and Supplied (Billions of Dollars) 4 Interest Rates • Equilibrium Interest Rate • Interest Rates and Bond Prices – Bond Prices Fall When Interest Rates Rise – Bond Prices Rise When Interest Rates Fall – Inverse Relationship Between Interest Rates and Bond Prices Bina Nusantara University 5 Tools of Monetary Policy • Open Market Operations – Buying Securities • From Commercial Banks • From the Public – Selling Securities • To Commercial Banks • To the Public • When the Fed Sells Securities, Commercial Bank Reserves are Reduced Bina Nusantara University 6 Tools of Monetary Policy Fed Buys $1,000 Bond from a Commercial Bank New Reserves $1000 $1000 Excess Reserves $5000 Bank System Lending Bina Nusantara University 7 Total Increase in the Money Supply, ($5,000) Tools of Monetary Policy Fed Buys $1,000 Bond from the Public Check is Deposited New Reserves $1000 $800 Excess Reserves $4000 Bank System Lending $200 Required Reserves $1000 Initial Checkable Deposit Bina Nusantara University 8 Total Increase in the Money Supply, ($5000) Tools of Monetary Policy • The Reserve Ratio – Raising the Reserve Ratio – Lowering the Reserve Ratio • The Discount Rate – Borrowing from the Fed by Banks Increases Reserves and Enhances Lending Ability • Relative Importance of Each Bina Nusantara University 9 Monetary Policy (a) (b) (c) The Market For Money Investment Demand Equilibrium Real GDP and the Price Level Sm1 Sm2 Sm3 AS 10 P3 Price Level Rate of Interest, i (Percent) Monetary Policy and Equilibrium GDP 8 AD3 I=$25 P2 Dm 6 $25 AD2 I=$20 ID AD1 I=$15 0 $125 $150 $175 Amount of Money Demanded and Supplied (Billions of Dollars) Bina Nusantara University $15 $20 $25 Amount of Investment, I (Billions of Dollars) Q1 Qf Q3 Real Domestic Product, GDP (Billions of Dollars) 10 Monetary Policy • • • • • Cause-Effect Chain Market for Money Investment Equilibrium GDP Effects of an Expansionary Monetary Policy • Effects of a Restrictive Monetary Policy Bina Nusantara University 11 Monetary Policy Expansionary Monetary Policy CAUSE-EFFECT CHAIN Problem: Unemployment and Recession Fed Buys Bonds, Lowers Reserve Ratio, or Lowers the Discount Rate Excess Reserves Increase Federal Funds Rate Falls Money Supply Rises Interest Rate Falls Investment Spending Increases Aggregate Demand Increases Bina Nusantara University 12 Real GDP Rises Monetary Policy Restrictive Monetary Policy CAUSE-EFFECT CHAIN Problem: Inflation Fed Sells Bonds, Increases Reserve Ratio, or Increases the Discount Rate Excess Reserves Decrease Federal Funds Rate Rises Money Supply Falls Interest Rate Rises Investment Spending Decreases Aggregate Demand Decreases Bina Nusantara University 13 Inflation Declines
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