Econ330 Ch5 Vocab And Equations

Front 1

Monetary Policy works primarily by

Interest rates are determined by

Back 1

manipulating interest rates
the demand and supply for bonds

Front 2

Bonds as financial assets:

Back 2

Theory of asset
demand and asset allocation. S&D for Bonds.

Front 3

Loanable funds:

Back 3

Supply & Demand for loanable
fund. Savings and Investment. Bond demand is one component of the aggregate supply of L.F.

Front 4

Liquidity Preference:

Back 4

View bonds as an alternative to holding money.

Front 5

Theory of Asset Demand
Holding all other factors constant:

Back 5

1. The quantity demanded of an asset is positively related to wealth
2. The quantity demanded of an asset is positively related to its expected return relative to alternative assets
3. The quantity demanded of an asset is negatively related to the risk of its returns relative to alternative assets
4. The quantity demanded of an asset is positively related to its liquidity relative to alternative assets

Front 6

Supply and Demand for Bonds
• At lower prices (higher interest rates)
• At lower prices (higher interest rates)

Back 6

ceteris paribus, the quantity demanded of bonds is higher—an inverse relationship

ceteris paribus, the quantity supplied of bonds is lower—a positive relationship

Front 7

demand curve

Back 7

interest rate = expected return = F-P/P
downward sloping

Front 8

supply curve

Back 8

upward sloping; P increases, QD increased

Front 9

market equilibrium

Back 9

Bd = Bs

Front 10

excess supply

Back 10

Bs > Bd
want to sell more bonds then pple are willing to buy, so P falls and interest rates rise

Front 11

excess demand

Back 11

Bd > Bs
want to buy more bonds then others are willing to sell; P driven up and interest rates fall

Front 12

asset market approach

Back 12

emphasizes stocks of assets rather than flows in det. asset prices

Front 13

shifts in demand curves

Back 13

Wealth—in an expansion with growing wealth, the demand curve for bonds shifts to the right
• Expected Returns—higher expected interest rates in
the future lower the expected return for long-term bonds, shifting the demand curve to the left
• Expected Inflation—an increase in the expected rate
of inflation lowers the expected return for bonds,
causing the demand curve to shift to the left
• Risk—an increase in the riskiness of bonds causes
the demand curve to shift to the left
• Liquidity—increased iquidity of bonds, D curve shifts right

Front 14

increase in wealth, D shifts

Back 14

rt

Front 15

increase in expected interest rate, D shifts

Back 15

lf

Front 16

Increase in expected inflation, D shifts

Back 16

lf

Front 17

increase in riskiness of bonds, D shifts

Back 17

lf

Front 18

Increase in liquidity of bonds, D shifts

Back 18

rt

Front 19

shifts of demand curve in:
expansion
recession

Back 19

rt
lt

Front 20

Factors that shift supply curves

Back 20

expected profitability of investment opportunities
expected inflation
govt. budget

Front 21

increase in expected profitability of investments, S shift

Back 21

rt

Front 22

increase in expected inflation, S shift

Back 22

rt

Front 23

increase in govt deficit, S shift

Back 23

rt

Front 24

when expected inflation rises, interest rates will ____ according to the fisher effect

Back 24

rise

Front 25

Liquidity preference framework

Back 25

det. equilibrium interest rate in terms of the supply of and demand for money
Bs+Ms=Bd+Md

Front 26

Derivation of Demand Curve

Back 26

1. Keynes assumed money has i = 0
2. As i ↑, relative RETe on money ↓ (equivalently, opportunity cost of money ↑) ⇒ Md ↓
3. Demand curve for money has usual downward slope

Front 27

Derivation of Supply curve

Back 27

1. Assume that central bank controls Ms and it is a fixed amount
2. Ms curve is vertical line
Market Equilibrium
1. Occurs when Md = Ms, at i* = 15%
2. If i = 25%, Ms > Md (excess supply): Price of bonds ↑, i ↓ to i* = 15%
3. If i =5%, Md > Ms (excess demand): Price of bonds ↓, i ↑ to i* = 15%

Front 28

Md and interest rate should be ______ related

Back 28

negatively

Front 29

According to keynes, increase in income and price level shift Md

Back 29

rt

Front 30

accord. to keynes, increase in Ms shifts Ms

Back 30

rt

Front 31

sources of bond risk

Back 31

default, inflation, interest rate

Front 32

default risk

Back 32

when issuer of bond is unable/unwilling to make interest pmts when promised/pay off FV when bond matures

Front 33

risk premium

Back 33

spread btwn interest rates on bonds w/default risk and default free bonds; indicates how much additional interest pple must earn to be willing to hold that risky bond