Slide 1MoneyQuestionThe Money Demand CurveQuestionMoney DemandMoney and Interest RatesIncreases and Decreases in the Demand for MoneyMoney SupplyEquilibrium in the Money MarketSlide 11Federal Funds RateThe Fed Reverses CourseMonetary PolicyExpansionary Monetary Policy to Fight a Recessionary GapTracking Monetary PolicyTracking Monetary PolicyThe Federal Reserve SystemWhat does the Fed do?QuestionReserve RatioDiscount rateWhat is in the Fed’s balance sheet?Open market sales of $100Open market purchase of $100 milSlide 26Slide 27Slide 28Slide 29Toxic AssetMonetary Base 1910 - 2010Monetary Base 1980 - 2013Slide 33Let’s think in L~~ong RunMoney, Output, and Prices in the Long RunThe Long-Run Determination of the Interest RateMonetary NeutralityBecause of Monetary NeutralityThe Long-Run Relationship Between Money and InflationMoney Supply Growth and Inflation in ZimbabweMoney and Prices in Brazil, 1985-1995Ch 15. Monetary PolicyMoneyQuestion) What determines the amount of YOUR holding of money? (simply think of amount of cash that you are holding)QuestionIf your bank gives you 15% of interest on your bank account, would you hold more or less amount of money?Interest rate & Money demand: −The Money Demand CurveInterest rate, rQuantity of moneyMoney demand curve, MDQuestion•If your income level increases by 10 times, would you hold more or less amount of money than now?•Income and money demand: +Money Demand•Changes in interest rate•Changes in aggregate price level : +•Changes in real GDP: +•Changes in technology: depends•Changes in institutions: dependsMoney and Interest Rates•According to the liquidity preference model of the interest rate, the interest rate is determined by the supply and demand for money.•The money supply curve shows how the nominal quantity of money supplied varies with the interest rate.Increases and Decreases in the Demand for MoneyA fall in money demand shifts the money demand curve to the left..A rise in money demandshifts the money demandcurve to the right.Money Supply•Q) Who controls Money supply in U.S?•A) The Fed•Q) How much is M1 in U.S. in October 2013?•A) $2.57 trillionMrHrErLLEMDMHMLHQuantity of moneyInterestrate, rEquilibrium interest rateMoney supplycurve, MSEquilibriumMoney supplychosen by the FedEquilibrium in the Money Market1M2E2MS2An increasein the moneysupply . . .r1EMS1MDM1Quantity of moneyInterestrate, rr2. . . leads toa fall in theinterest rate.The Effect of an Increase in the Money Supply on the Interest RateFederal Funds Rate•Interest rate in Federal Funds Market•Federal Funds Market: where banks lend balances to each other over night.•What is current Federal Funds rate in U.S.?•0-0.25%The Fed Reverses CourseMonetary Policy-Expansionary : increasing Money supply  interest rate-Down-Investment spending would -Increase, -Consumption would-Increase,-Aggregate demand would-increaseExpansionary Monetary Policy to Fight a Recessionary GapTracking Monetary PolicyTracking Monetary Policy1985Q11986Q21987Q31988Q41990Q11991Q21992Q31993Q41995Q11996Q21997Q31998Q42000Q12001Q22002Q32003Q42005Q12006Q22007Q32008Q42010Q1-8%-6%-4%-2%0%2%4%6%8%10%12%Federal funds rate (Taylor rule) Federal funds rateYearFederal funds rateThe Federal Reserve SystemWhat does the Fed do?-Regulates the market-Overseas the market-Monetary policyQuestion•If federal reserve wants to stimulate the economy what do they do?•Three tools•Reserve Ratio•Discount rate•Open market Operation•Discount rateReserve Ratio •If ratio is 10%, and Monetary base increases by 100, how much money supply increases in total?•Money supply = (1/0.1) * 100 = 1,000•If reserve ratio is 5%, and monetary base increases by 100, how much money supply increases in total?•Money supply = (1/0.05) * 100 = 2,000 Lower the reserve ratio, Higher the Money supplyDiscount rateThe federal funds rate is the interest rate determined in the federal funds market.The discount rate is the rate of interest the Fed charges on loans to banks.If discount rate gets lowerIt gets cheaper to borrow for banks Monetary base increases ( Money supply up)What is in the Fed’s balance sheet?•What is asset of the feds?•What is liability of the feds?Open market sales of $100Open market purchase of $100 milhttp://www.npr.org/blogs/money/2010/08/31/129558498/the-tuesday-podcast-how-to-spend-1-249-999-999-999-3910/ 18/ 10 10:26 PMThe Tuesday Podcast: The Fed Wants To Sell You A Mall In Oklahoma : Planet Money : NPRPage 1 of 4http:/ / www.npr.org/ blogs/ money/ 2010/ 04/ the_tuesday_podcast_the_fed_wa.htmlThe Tuesday Podcast: The Fed Wants To Sell You A MallIn OklahomaCategories: Podcast04:04 pmApril 6, 2010by JACOB GOLDSTEINOn today's PlanetMoney:The FederalReserve owns thebiggest mall inOklahoma, and it'slooking to sell.The mall is one ofthe many, manyassets the Fedbought to bail outBear Stearns a fewyears back. Theassets werebundled into aspecial companycalled Maiden LaneI.Also on the bank'sshopping list: A bundle of home mortgages that's closely related to Toxie, PlanetMoney's toxic asset. (Does that make us, like, in-laws with the Fed?) For the most part, the Fed owns financial stuff like loans and swaps. The assets itbought as part of the Bear bailout included a mortgage on the Crossroads Mall inOklahoma City. When the owners of the mall defaulted on the mortgage, the FedPlanet Money Blog(UrbanReviewSTL via Flickr)The Fed's mall10/ 18/ 10 10:26 PMThe Tuesday Podcast: The Fed Wants To Sell You A Mall In Oklahoma : Planet Money : NPRPage 1 of 4http:/ / www.npr.org/ blogs/ money/ 2010/ 04/ the_tuesday_podcast_the_fed_wa.htmlThe Tuesday Podcast: The Fed Wants To Sell You A MallIn OklahomaCategories: Podcast04:04 pmApril 6, 2010by JACOB GOLDSTEINOn today's PlanetMoney:The FederalReserve owns thebiggest mall inOklahoma, and it'slooking to sell.The mall is one ofthe many, manyassets the Fedbought to bail outBear Stearns a fewyears back. Theassets werebundled into aspecial companycalled Maiden LaneI.Also on the bank'sshopping list: A bundle of home mortgages that's closely related to Toxie, PlanetMoney's toxic asset. (Does that make us, like, in-laws with the Fed?) For the most part, the Fed owns financial stuff like loans and swaps. The assets itbought as part of the Bear bailout included a mortgage on the Crossroads Mall inOklahoma City. When the owners of the mall defaulted on the mortgage, the FedPlanet Money Blog(UrbanReviewSTL via Flickr)The Fed's