Welcome to Econ 414 International Economics Study Guide Week Fourteen 1 Asst 7 9 Page 316 Key a Supply of pound goes down because due to decrease in their income British can t afford to buy as many US goods as before S2 pound S1 D pounds Pound appreciates 2 Part b US residents have more income They will demand more British goods Demand increases pound S Pound appreciates D2 D1 pounds 3 Part c Due to inflation in the US both Americans British would want to buy more British goods Therefore Supply decreases and demand increases pound S2 S1 Pound will appreciate D2 D1 pounds 4 Part d American s purchasing poser goes down So they will demand fewer British goods Demand for pound goes down pound S Pound will depreciate D1 D2 pounds 5 CHAPTER 14 Money Interest Rates and the Exchange Rate 6 What is money Anything that can be used for final discharge a debt Credit card is not money Balance in checking account is money Coins and currency are money 7 What can money be used for 1 Medium of Exchange What is the main problem with barter economy It requires double coincidence of wants 2 Unit of Account Measure and compare values Makes economic transactions easier to compare 8 What can money be used for 3 Store of Value Save now spend later Smoothes inconsistencies between money earned and money spent Note Individuals in high inflation countries my keep other currencies or goods as a store of value 9 What is the Supply of Money Coins and paper currency act as primary mediums of exchange money Demand deposits held at banks and depository institutions provide the same function as currency money 10 The Supply of Money M1 Is total quantity of currency plus demand deposits narrow money internationally There are broader measures of money such as M2 M3 etc They include other less liquid assets M1 M2 M3 11 What is Monetary Base B Cash held by the public C and the total quantity of bank reserves R on deposit at central bank B C R 12 What is Reserve Requirement The percentage of deposits r banks are legally required to keep on deposit with the central bank 13 What is Money Multiplier MM The reciprocal of the reserve requirement MM 1 r Money supply M1 is equal to the monetary base multiplied by the money multiplier MS M1 1 r B 14 Example 80 Cash in hands of the public 230 Bank Reserve Required reserve 0 1 What is MS MS 1 0 1 310 MS 3100 15 Monetary policy Refers to central bank changing money supply by changing the monetary base and or the money multiplier MS M1 1 r B MS if B or if r 16 How can the central bank change B or r 1 Change the interest rate banks pay on borrowed money from the central bank Discount Rate US Marginal Lending rate Europe Lower interest rate increase in borrowed reserves B MS 17 How can the central bank change B or r 2 Changing reserve requirement r Lower reserve requirement means banks could make more loans If r MM MS Rarely used b c effect too powerful 18 How can the central bank change B or r 3 Open Market Operations refinancing Buying and selling bonds by central bank If the central bank buys bonds money is given to bond seller public or bank and more money is in the economy B MS 19 Money Supply Curve Controlled by the central bank Interest Rate i MS2 Money Supply MS MS1 Contractionar Expansionar y monetary y monetary policy policy Money M1 20 I received a question Can you please explain again with some examples the open market operations thank you 21 Answer Bank of Ireland has some government bonds If the central bank wants to increase the supply of money Offer higher than normal prices for bonds Bank of Ireland sell their 1000 bond to the central bank Central bank makes a 1000 deposit into their Bank of Ireland Reserve Account at the central bank Bank of Ireland s reserves goes up Bank of Ireland make more loans that means the people borrowers will have more money in their checking accounts borrowed M1 goes up MS goes up 22 The central bank supplies money Who demands money Firms individuals 23 Why do we demand money M1 1 To buy goods and services Transactions demand for money Varies directly with nominal GDP 2 In case of emergencies that require purchases above normal spending levels Precautionary demand for money 3 As an asset 24 Three motivations for holding money combine to create the aggregate demand for money If interest rates go up do we demand more or less money Less interest rate is the opportunity cost of holding money If the price level goes up do we demand more or less money More need more money to cover our purchases 25 If our income goes up will we demand more or less money More Can afford to buy more goods and services Money demand related to interest rate price level and real income as MD f i P Y i Interest rate P Price level Y Real GDP 26 Money Demand Curve Interest Rate i Shows the relationship between interest rate and the quantity of money demanded holding everything else constant Demand for Money MD Money M 27 What shifts the Money Demand Curve D1 Interest Rate i Increase to D1 if P or Y D2 Decreas e to D2 if P or Y Demand for Money MD Money M 28 The Equilibrium Interest Rate The Interaction of Money Supply and Money Demand Interest Rate i Supply for Money MS i Demand for Money MD Money M 29 How does an increase in the price level affect the interest rates Interest Rate i i 2 i MD i Supply for Money MS G E MD2 Demand for Money MD Money M 30 How does a economic recession affect the interest rate Supply for Money MS Interest Rate i MD i i E i 1 F Demand for MD1 Money MD Money M 31 How does an open market sale by the central bank affect the interest rate Interest Rate i i 2 i MS2 Supply for Money MS MS i This is a contractionary monetary policy Demand for Money MD Money M 32 Another Question I m trying to understand the example in page 329 about appreciation and depreciation but I think there s something wrong in it Can you do it in class 33 My answer Let go over it together 34 How does the interest rate relate to the exchange rate Interest Arbitrage Relationship between interest rates and the exchange rate in the short run 35 The Interest Rate And the Exchange Rate in the Short Run Example You own a company in U S looking to invest 10 000 cash Assume U K has the best rate of 12 You must first buy pounds in the foreign exchange market then invest pounds in U K market If spot exchange rate is 2 pound which gives you 5000 …