1

THE BANK OF CANADA AND MONETARY POLICY

Chapter 14 Instructor Shan A Garib Fall 2012

141 The Bank of Canada A central bank is an institution that oversees

and regulates the banking system and controls the monetary base

The BoC is a central bankmdashan institution that oversees and regulates the banking system and controls the monetary base

142 The Tools of Monetary Policy

bull The most important job of the BoC is to control the rate of growth of the money supply

bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is

open-market operations

How Open-Market Operations Work

bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills

notes certificates and bondsndash The Fed buys and sells securities that have

already been marketed by the Treasurybull The total value of all outstanding CAN government

securities is more than $10 trillion This is our national debt

ndash What open market operations consist of then is the buying and selling of chunks of the national debt

How the Fed Increases the Money Supply

The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100ReqRes - 10

ExcessRes+90

The multiplier would be 1010 X 90 million = 900 million loans to earn interest

RD redeposit BoC deposit

DD drawn down

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

141 The Bank of Canada A central bank is an institution that oversees

and regulates the banking system and controls the monetary base

The BoC is a central bankmdashan institution that oversees and regulates the banking system and controls the monetary base

142 The Tools of Monetary Policy

bull The most important job of the BoC is to control the rate of growth of the money supply

bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is

open-market operations

How Open-Market Operations Work

bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills

notes certificates and bondsndash The Fed buys and sells securities that have

already been marketed by the Treasurybull The total value of all outstanding CAN government

securities is more than $10 trillion This is our national debt

ndash What open market operations consist of then is the buying and selling of chunks of the national debt

How the Fed Increases the Money Supply

The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100ReqRes - 10

ExcessRes+90

The multiplier would be 1010 X 90 million = 900 million loans to earn interest

RD redeposit BoC deposit

DD drawn down

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

142 The Tools of Monetary Policy

bull The most important job of the BoC is to control the rate of growth of the money supply

bull This effort focuses on the reserves held by financial institutionsndash The most important policy tool to do this is

open-market operations

How Open-Market Operations Work

bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills

notes certificates and bondsndash The Fed buys and sells securities that have

already been marketed by the Treasurybull The total value of all outstanding CAN government

securities is more than $10 trillion This is our national debt

ndash What open market operations consist of then is the buying and selling of chunks of the national debt

How the Fed Increases the Money Supply

The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100ReqRes - 10

ExcessRes+90

The multiplier would be 1010 X 90 million = 900 million loans to earn interest

RD redeposit BoC deposit

DD drawn down

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How Open-Market Operations Work

bull Open-Market operations are the buying and selling of CAN government securitiesbondsndash CAN government securities are Treasury bills

notes certificates and bondsndash The Fed buys and sells securities that have

already been marketed by the Treasurybull The total value of all outstanding CAN government

securities is more than $10 trillion This is our national debt

ndash What open market operations consist of then is the buying and selling of chunks of the national debt

How the Fed Increases the Money Supply

The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100ReqRes - 10

ExcessRes+90

The multiplier would be 1010 X 90 million = 900 million loans to earn interest

RD redeposit BoC deposit

DD drawn down

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The CAN buys CAN Government SecuritiesThe BOC writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100ReqRes - 10

ExcessRes+90

The multiplier would be 1010 X 90 million = 900 million loans to earn interest

RD redeposit BoC deposit

DD drawn down

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = Interest Paid

Price of Bond

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

If the Fed goes on a buying spree it will quickly drive up the prices of CAN government securities

IR = $80

$1000= 8

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

Suppose this pushed the price of the bond up to $1200

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Increases the Money Supply

The Fed writes a check for say $100 million (this is money created out of nothing)

Securities Firm

DD + $100

Assume 10 RR

RD + $100RR - 10 ER + 90

When the Fed goes into the open market to buy securities it bids up their price and lowers their interest rate

IR = $80

$1000= 8

IR = $80

$1200= 667

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond and notes prices fall and interest rates climb

The money supply decreases

The CAN buys CAN Government Securities

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

How the Fed Decreases the Money Supply

The Security firm writes a check for say $100 million to the Fed (this check is in effect destroyed)

Securities Firm

DD - $100

Assume 10 RR

RD - $100

When the Fed goes into the open market to sell securities bond prices fall and interest rates climb

IR = $80

$1000= 8

IR = $80

$1200= 667

The money decreases

The CAN buys CAN Government Securities

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

bull The discount rate is the interest rate paid by member banks when they borrow reserve deposits (RD) at the BOC

bull The federal funds rate is the interest rate banks charge each other for borrowing reserve deposits (RD) from each otherndash This is higher than the discount rate

bull Banks borrow to maintain their required reserves (RR)ndash Banks tend to borrow reserve deposits from

each other because they may not like to call attention to the fact they are having to borrow reserve deposits

Borrowing Reserve Deposits

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Changing Reserve Requirements

bull To fight inflation before the Board would take the drastic step of raising reserve requirementsndash raise the discount ratendash Credit will be getting tighter

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Changing Reserve Requirements

bull If the money supply is still growing too rapidly ndash the Fed reaches for its biggest stick and raises reserve requirementsndash This weapon is so rarely used because it is

simply too powerfulndash If the reserve requirement on demand deposits

were raised by just one-half of 1 the nationrsquos banks and thrift institutions would have to come up with nearly $4 billion in reserves

bull This would drastically reduce the nationrsquos money supply

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Summary The Tools of Monetary Policy

bull To fight recession the BofC willndash Lower the discount rate (Prime rate)ndash Buy securities on the open marketndash Lower reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Summary The Tools of Monetary Policy

bull To fight inflation the Fed willndash Raise the discount ratendash Sell securities on the open marketndash Raise reserve requirements

bull This would be done only as a last resort

An Importa

nt Slid

e

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Tools of Monetary Policy

bull Changing the reserve requirement

bull Changing the discount rate

bull Executing open market operations (buying and selling government securities) and thereby affecting the Federal funds rate

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Reserve Requirement and the Money Supply

bull The Fed can increase or decrease the money supply by changing the reserve requirement

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Reserve Requirement and the Money Supply

bull If the Fed decreases the reserve requirement it expands the money supply

ndash Banks have more money to lend outndash The money multiplier increases

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Reserve Requirement and the Money Supply

bull If the Fed increases the reserve requirement it contracts the money supply

ndash Banks have less money to lend outndash The money multiplier decreases

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Changing the Discount Rate

bull A bank can borrow reserves directly from the Fed if it experiences a shortage of reserves

bull The discount rate is the rate of interest the Fed charges for those loans it makes to banks

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Changing the Discount Rate

bull By changing the discount rate the Fed can expand or contract the level of bank reserves and the money supply

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Changing the Discount Rate

bull An increase in the discount rate makes it more expensive for banks to borrow from the Fed

bull A decrease in the discount rate makes it less expensive for banks to borrow from the Fed

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

143 The Demand of Money

bull Foregone interest is the opportunity cost (price) of money people choose to hold

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Demand for Money

bull The demand for money is the quantities of money people are willing and able to hold at alternative interest rates ceteris paribus

bull A portfolio decision is the choice of how (where) to hold idle funds

LO1

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Demand for Money

bull Although holding money provides little or no interest there are reasons for doing so

ndash Transactions demandndash Precautionary demandndash Speculative demand

LO1

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Demand for Money

bull Transactions demand for money ndash Money held for the purpose of making everyday market purchases

bull Precautionary demand for money ndash Money held for unexpected market transactions or for emergencies

LO1

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Demand for Money

bull Speculative demand for money ndash Money held for speculative purposes for later financial opportunities

LO1

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Why Hold Money

bull John Maynard Keynes noted that people had three reasons for holding moneyndash People hold money to make transactionsndash People hold money for precautionary reasonsndash People hold money to speculate

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Why Hold money

bull Economists have since identified four factors that influence the three Keynesian motives for holding moneyndash The price levelndash Incomendash The interest ratendash Credit availability

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Keynesian Motives for Holding Money

bull The transaction motivendash Individuals have day-to-day purchases for

which they pay in cash or by checkndash Individuals take care of their rent or

mortgage payment car payment monthly bills and major purchases by check

ndash Businesses need substantial checking accounts to pay their bills and meet their payrolls

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Keynesian Motives for Holding Money

bull The precautionary motivendash People will keep money on hand just in

case some unforeseen emergency arises

bull They do not actually expect to spend this money but they want to be ready if the need arises

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Keynesian Motives for Holding Money

bull The speculative motivendash When interest rates are very low you

donrsquot stand to lose much holding your assets in the form of money

ndash Alternatively by tying up your assets in the form of bonds you actually stand to lose money should interest rates rise

bull You would be locked into very low rates

ndash This motive is based on the belief that better opportunities for investment will come along and that in particular interest rates will rise

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Four Influences on the Demand for Money

bull The price levelndash As the price level rises people need to hold

higher money balances to carry out day-to-day transactions

ndash As the price level rises the purchasing power of the dollar declines so the longer you hold money the less that money is worth

ndash Even though people tend to cut down on their money balances during periods of inflation as the price level rises people will hold larger money balances

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Four Influences on the Demand for Money

bull Incomendash The more you make the more you

spendndash The more you spend the more money

you need to hold as cash or in your checking account

ndash Therefore as income rises so does the demand for money balances

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Four Influences on the Demand for Money

bull Interest ratesndash The quantity of money demanded (held)

goes down as interest rates risebull The alternative to holding your assets in the

form of money is to hold them in some type of interest bearing paper

bull As interest rates rise these assets become more attractive than money balances

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Four Influences on the Demand for Money

bull Credit availabilityndash If you can get credit you donrsquot need to

hold so much moneybull The last three decades have seen a veritable

explosion in consumer credit in the form of credit cards and bank loans

bull Over this period increasing credit availability has been exerting a downward pressure on the demand for money

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Four Influences on the Demand for Money

bull Four generalizationsndash As interest rates rise people tend to

hold less moneyndash As the rate of inflation rises people

tend to hold more moneyndash As the level of income rises people

tend to hold more moneyndash As credit availability increases people

tend to hold less money

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

The Demand Schedule for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

100 200 300 400

Transactionsdemand

ATransactions demand

20

10

100 200

Precautionarydemand

B Precautionary demand

20

10

100 200 300 400 500 600 700 800 900 1000

Speculativedemand

C Speculative demand

The Three Demands for Money

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Total Demand for Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

2000 400 600 800 1000 1200 1400 1600 1800

Total demandfor money

This is the sum of the transaction demand precautionary demand and speculative demand for money shown in the previous slide

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Total Demand for Money and the Supply of Money

Quantity of money (in $ billions)

20

18

16

14

12

10

8

6

4

2

Total demandfor money

M

72

2000 400 600 800 1000 1200 1400 1600 1800

The interest rate of 72 percent is found at the intersection of the total demand for money and the supply of money (M)

Since at any given time the supply of money (M) is fixed it can be represented as a vertical line

As money supply increases interest rates fall and I incrases gtgt AD incrases

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

Liquidity Trap

bull The liquidity trap is the portion of the money-demand curve that is horizontal

bull People are willing to hold unlimited amounts of money at some (low) interest rate

LO2

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

144 The Equation of Exchange1048707 The formula indicating that the number of monetary units times the number of times each unit is spent on final goods and services is identical to the price level times real GDP

MsV = PY

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

The equation of exchange and thequantity theory

MSV = PY

1048707 MS = actual money balances held by nonbanking public

1048707 V = income velocity of money

The number of times on average per year each monetary unit is spent on final goods and services

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

Income Velocity of Money

1048707 The number of times per year the dollar is spent on final goods and services

equal to the nominal GDP divided bythe money supply

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

Income Velocity of Money

The equation of exchange and thequantity theory

MSV = PY

1048707 P = price level or price index1048707 Y = real GDP per year

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

The equation of exchange asan identity1048707 Total funds spent on final output MsV

equals total funds received PY

1048707 The value of goods purchased is equal to the value of goods sold

1048707 MsV = PY = nominal GDP

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

Quantity Theory of Money and Prices1048707 The hypothesis that changes in the money supply lead to equiproportional changes in the price level

The quantity theory of moneyand prices1048707 Assume

V is constantY is stable

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50

LO2

The quantity theory of moneyand prices

1048707 Increases in Ms must be matched by equal increases in the price level

• The Bank of Canada and Monetary Policy
• 141 The Bank of Canada
• 142 The Tools of Monetary Policy
• How Open-Market Operations Work
• How the Fed Increases the Money Supply
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• How the Fed Decreases the Money Supply
• Slide 12
• Borrowing Reserve Deposits
• Changing Reserve Requirements
• Slide 15
• Summary The Tools of Monetary Policy
• Slide 17
• Tools of Monetary Policy
• The Reserve Requirement and the Money Supply
• The Reserve Requirement and the Money Supply
• Slide 21
• Changing the Discount Rate
• Slide 23
• Changing the Discount Rate
• 143 The Demand of Money
• The Demand for Money
• Slide 27
• Slide 28
• Slide 29
• Why Hold Money
• Why Hold money
• The Keynesian Motives for Holding Money
• The Keynesian Motives for Holding Money
• Slide 34
• Four Influences on the Demand for Money
• Four Influences on the Demand for Money
• Slide 37
• Slide 38
• Slide 39
• The Demand Schedule for Money
• Total Demand for Money
• Total Demand for Money and the Supply of Money
• Liquidity Trap
• PowerPoint Presentation
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50