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After reading this chapter, you should be able to: Discuss how the equilibrium interest rate is determined in the market for money, list and explain the goals and tools of monetary policy, describe the Federal funds rate and how the Fed directly influences it, identify the mechanisms by which monetary policy affects GDP and the price level, explain the effectiveness of monetary policy and its shortcomings. | Interest Rates and Monetary Policy McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Interest Rates The price paid for the use of money Many different interest rates Speak as if only one interest rate Determined by the money supply and money demand LO1 33- Demand for Money Why hold money? Transactions demand, Dt Determined by nominal GDP Independent of the interest rate Asset demand, Da Money as a store of value Varies inversely with the interest rate Total money demand, Dm LO1 33- Demand for Money Rate of interest, i percent 10 7.5 5 2.5 0 50 100 150 200 50 100 150 200 50 100 150 200 250 300 Amount of money demanded (billions of dollars) Amount of money demanded (billions of dollars) Amount of money demanded and supplied (billions of dollars) = + (a) Transactions demand for money, Dt (b) Asset demand for money, Da (c) Total demand for money, Dm and supply Dt Da Dm Sm 5 LO1 33- Assets Securities Loans to commercial banks Liabilities Reserves of commercial banks Treasury deposits Federal Reserve Notes outstanding LO2 Federal Reserve Balance Sheet 33- Tools of Monetary Policy Open market operations Buying and selling of government securities (or bonds) Commercial banks and the general public Used to influence the money supply When the Fed sells securities, commercial bank reserves are reduced LO2 33- Tools of Monetary Policy Fed buys bonds from commercial banks Assets Liabilities and Net Worth Federal Reserve Banks + Securities + Reserves of Commercial Banks (b) Reserves Commercial Banks Securities (a) +Reserves (b) Assets Liabilities and Net Worth LO2 (a) Securities 33- Tools of Monetary Policy Fed sells bonds to commercial banks Assets Liabilities and Net Worth Federal Reserve Banks - Securities - Reserves of Commercial Banks Commercial Banks + Securities (a) - Reserves (b) Assets Liabilities and Net Worth (a) Securities (b) Reserves LO2 33- Tools of Monetary Policy The . | Interest Rates and Monetary Policy McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Interest Rates The price paid for the use of money Many different interest rates Speak as if only one interest rate Determined by the money supply and money demand LO1 33- Demand for Money Why hold money? Transactions demand, Dt Determined by nominal GDP Independent of the interest rate Asset demand, Da Money as a store of value Varies inversely with the interest rate Total money demand, Dm LO1 33- Demand for Money Rate of interest, i percent 10 7.5 5 2.5 0 50 100 150 200 50 100 150 200 50 100 150 200 250 300 Amount of money demanded (billions of dollars) Amount of money demanded (billions of dollars) Amount of money demanded and supplied (billions of dollars) = + (a) Transactions demand for money, Dt (b) Asset demand for money, Da (c) Total demand for money, Dm and supply Dt Da Dm Sm 5 LO1 33- Assets Securities Loans to commercial .
