MGEA06H3 Lecture Notes - Lecture 10: Nominal Interest Rate, Inflation Targeting, Monetary Transmission Mechanism

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Chapter 15 Monetary Policy
Outline
Introduce the money demand curve and factors affecting the money demand.
Introduce the theory of liquidity preference and using it to determine the
interest rate.
Discuss the monetary policy transmission mechanism.
Incorporate monetary policy in the income-expenditure model and the AS-
AD model.
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The Demand for Money
The demand for money (MD) comes from households and firms who want to
hold money to facilitate their daily transactions and/or to store their wealth.
Let’s examine factors that affect the demand for money.
The Opportunity Cost of Holding Money
We can store our wealth in different types of assets:
Monetary assets such as cash and bank deposits.
Interest-bearing, non-monetary assets such as bonds, stocks and etc.
The choice between holding monetary assets and non-monetary assets
involves a trade-off between convenience and earning interest.
Monetary assets offer convenience (can be converted into money easily)
but they offer little to no interest/return.
Non-monetary assets offer returns to holders but they does not provide
convenience (it takes time to convert these assets into money).
Therefore, the demand for money, to some extent, comes from the choice of
holding our wealth in the form of monetary assets.
Holding all else constant, an increase in interest rate raises the
opportunity cost of holding money, households and firms would like to
hold more interest-bearing assets and fewer monetary assets the
demand for money falls.
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The Money Demand Curve
The money demand (MD) curve shows the relationship between the
quantity of money demanded and the interest rate.
Given the interest rate represents the opportunity cost of holding money,
there is an inverse relationship between the quantity of money demanded
and the interest rate the money demand curve is downward sloping.
Interest rate, i
(Nominal) MD
Quantity of money, M
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MGEA06H3 Full Course Notes
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Document Summary

Shifts of the money demand curve (cid:120) factors affect the willingness to hold money other than interest rate will shift the md curve. When p (cid:110), we need to hold more money to buy the same amount of goods and services. When y (cid:110), c (cid:110) (cid:159) we need to hold more money to facilitate a larger volume of transactions. This allows people to make purchase technology such as without holding money. introduction of credit card. This lowers the opportunity cost of as the introduction of holding money. chequable-savings accounts* * these accounts provide convenience to depositors but without requiring depositors to give up interest. Money and interest rates (cid:120) using the theory of liquidity preference to discuss the determination of interest rate. 1 in here, we assume the level of ms chosen by the boc will be the level will achieve its interest rate target. Monetary policy and the interest rate in the short run.

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