Thursday, March 11th, 2010
Interest Rate Determination (Short-Run)
Money Supply: Currency + bank deposits
Money Supply, Money Demand: determine interest rate
What are determinants of Money demand?
The Demand for Money: Intuition
Households hold two assets
Money (currency + bank deposits): pays no interest
Bonds: pay interest
You have: money $1,000
Would you increase or reduce money holdings if:
(1) The interest rate rises from 5% to 10%?
(2) Your income rises, so you will be spending more on goods and services?
(3) Prices in the economy increase, so you will have to pay more for the same goods and
services you plan to purchase?
Demand for Money
Falls as interest rates 1. Money does not pay interest
increases 2. opportunity cost (interest forgone) of holding
Rises as real GDP increases real volume of transactions increases
Rises (proportionately) dollar volume of transactions increases
as price level increases
Symbol for interest rate