Lecture Essentials of economics (3/e): Chapter 15 - Brue, McConnell, Flynn

Chapter 15 - Interest rates and monetary policy. This chapter starts by introducing the transactions and asset demand for money and explaining how the interaction of the demand and supply of money determines the interest rates in the market. We will learn about tools other than open market operations that the Fed might use to manipulate the money supply and the reasons that these tools are chosen, or not chosen.

Chapter 15

Interest Rates and Monetary Policy

money demand

20-year Treasury Bond rate

(interest rate on federal government security used to finance the public debt)

4.05%

90-day Treasury Bill rate

(interest rate on federal government security used to finance the public debt)

0.02

Prime interest rate

(interest rate used as a reference point for a wide range of bank loans)

3.25

30-year mortgage rate

(fixed-interest rate on loans for houses)

4.60

4-year automobile loan rate

(interest rate for new autos by automobile finance companies)

4.05

Tax-exempt state and municipal bond rate

(interest rate paid on a low-risk bond issued by a state or local government)

4.65

Federal funds rate

(interest rate on overnight loans between banks)

0.08

Short-Term Interest Rate, 2011

Amount of money demanded (billions of dollars)

Amount of money demanded and supplied (billions of dollars)

= +

money, D a

(c)

Total demand for

and money demand

securities (or bonds)

public

commercial bank reserves are reduced

Tools of Monetary Policy

e Deposits

(3) Actual Reserves

(4) Required Reserves

(5) Excess Reserves, (3) –(4)

(6) Money- Creating Potential of Single Bank,

= (5)

(7) Money- Creating Potential of Banking System

important

Monetary Policy

Monetary Policy

Level

Investment demand

(c)

Equilibrium real GDP and the price level

AS

Problem: Unemployment and Recession

Fed buys bonds, lowers reserve ratio, or lowers

the discount rate Excess reserves increase Federal funds rate falls Money supply rises Interest rate falls Investment spending increases Aggregate demand increases

Problem: Inflation

Fed sells bonds, increases reserve ratio, or

increases the discount rate Excess reserves decrease Federal funds rate rises Money supply falls Interest rate rises Investment spending decreases Aggregate demand decreases

fiscal policy

Prime interest rate

Federal funds rate

Monetary Policy

actions during the recent financial

crisis and the severe recession

the crisis by keeping the Federal

funds rate too low for too long

activities

Money Market Mutual Fund

Liquidity Facility

•