Chapter 14 Macroeconomics

Front 1

d: monetary policy

Back 1

the various tools the fed uses to influence the macroeconomy

Front 2

how does the fed control the money supply

Back 2

by using tools that control the interest rate

Front 3

d: demand for money

Back 3

how much money people would like to hold given the constraints that they face

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d: wealth constraint

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at any given point in time wealth is fixed, stock variable, means that you must give up one kind of wealth in order to acquire another
if we want to hold wealth in the form of money we must hold less wealth in other forms: savings accounts, money market funds, time deposits, stocks, bonds, etc

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is wealth a fixed or stock variable

Back 5

stock
at one point in time

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whats a household's quantity demanded for money

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household’s quantity of money demanded is the amount of wealth that the household chooses to hold as money rather than other assets

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d: capital gain

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rise in value of a stock

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whats the opp cost of holding money

Back 8

the interest you could have earned by holding other assets instead

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households can divide wealth between two assets:

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1) money which can be used as a means of payment but earns no interest
2) bonds which earn interest but cannot be used as a means of payment

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Determinants of Whether We Hold Wealth as Money or Bonds

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1) price level
2) real income
3) interest rates

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demand for money increases when

Back 11

1) price level rises
2) real income/purchasing power/ real gdp rises
3) interest rates fall

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demand for money decreases when

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1) price level decreases
2) real income/purchasing power/real gdp decreases
3) interest rates rise

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demand for money by businesses

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same as households

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when theres a change in interest rate, the demand curve will

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not shift, theres a movement along

Front 15

who controls the supply of money

Back 15

the Fed

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characteristics of supply line

Back 16

vertical
fixed amount

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how is the money supply increased

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purchase of bonds
(amount purchased X money multiplier= effect)

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d: loanable funds market

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where a flow of loanable funds is offered by lenders to borrowers (long run)

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in the short run, equilibrium is found in the

Back 19

money market graph

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d: money market

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the interest rate at which the Q of money demanded and the Q of money supplied are equal (Y= interest rate, X= $)

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axises on the money market graph

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y is interest rate

x is money

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what does the money supply line tell us

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e. The Ms line tells us the amount of money that actually exists in the economy, tells us the amount of money that people are actually holding at any given moment

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at equilibrium the amount of money being held is

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being willingly held

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d: excess demand for bonds

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the amount of bonds demanded exceeds the amount supplied at a particular interest rate, there’s an excess supply of money, the price of bonds will rise, decrease in the interest rate

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d: Excess supply of money

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the amount of money supplied exceeds the amount demanded at a particular interest rate, the price of bonds will rise, decrease in the interest rate

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when there is an excess demands for bonds

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theres an excess supply of money
price of bonds will rise
decrease in the interest rate

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when there is an excess supply of money

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theres an excess demand for bonds
price of bonds will rise
decrease in the interest rate

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when theres an excess demand for money

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excess supply of bonds
price of bonds decrease
interest rates increase

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when theres an excess supply of bonds

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excess demand for money
price of bonds decrease
interest rates increase

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d: Bond

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promise to pay back borrowed funds at a certain date or dates in the future

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d: interest payment

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the amount you earn from the purchase price of the bond minus the amount you actually paid

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d: interest rate

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(purchase price-amount paid)/amount paid

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the higher the price of the bond....

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the lower the interest rate

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d: secondary bond market

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where bonds issued in previous periods are bought and sold, if there is an increase in the interest rates of this market, the interest rates increase in the primary market because the bonds are substitutes

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d: primary bond market

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bonds newly issued are bought

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if theres an increase in IR the secondary bond market, the IR in the primary bond market will

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increase since the bonds are susbtitutes

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To Lower the Interest Rate

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Purchase Bonds
Money Supply Shifts to the Right
Excess supply of money and excess demand for bonds
Price of Bonds Increases
Interest Rate Decreases

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To Increase the Interest Rate

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Sell Bonds
Money Supply Shifts to the Left
Excess demand for money and excess supply of bonds
Price of bonds Decreases
Interest Rate Increases

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A drop in the interest rate will boost several different types of spending

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Stimulates business spending on plant an equipment
Buying on new houses and apartments increases, since people borrow money to buy these things
Spending on big ticket items (consumer durables) increases

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d: consumer durables

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big ticket items such as new cars, furniture and dishwashers, last several years

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lower interest rate causes

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higher consumption, and causes a shift of the consumption function, rise in autonomous consumption spending

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how does monetary policy work

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Bonds are bought
Money supply increases
Interest rate decreases
Autonomous consumption and planned investment increases
Real gdp increases
AE line shifts out

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whats the point of the Fed targeting interest rates

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To prevent fluctuations in money demand from affecting the economy the Fed adjusts the money supply to maintain its interest rate target

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how does the Fed change its interest rate target

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to prevent or address unwanted changes in AE, the fed changes its interest rate target adjusting the money supply as needed to reach it

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why does the Fed generally only need to change the Fed funds rate

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interest rates tend to rise and fall together, so targeting any one influences all of them

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d: federal funds market

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the interest rate paid on loans in a market that it can very easily monitor and control, banks with excess reserves lend them out to other banks for very short periods

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d: federal funds rate

Back 47

the interest rate in the federal funds market

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d: conventional monetary policy

Back 48

when the Fed guides the economy by controlling the fed funds rate

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conditions that Make the Fed’s Conventional Monetary Policy Less Effective

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Changing interest rate spreads
The zero lower bound
Financial crises

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d: interest rate spread

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the difference between an interest rate and some other benchmark interest rate

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during normal times, risks are perceived as stable so the spread is somewhat constant, so the Fed can change ...

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the Fed funds rate and see a change on the interest rates of long term loans

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times of perceived different risks can affect

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the spread between the Fed funds rate and long term loans

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unconventional Policy to Alter Spreads

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could purchase any type of asset to alter the rate of return and affect interest rates

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d: zero lower bound

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the lowest possible value (0) for any nominal interest rate (such as the Fed funds rate)

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unconventional Policy at the Zero Lower Bound

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intervene and alter other interest rates
lower the real rate on interest through inflation