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ECO102H1 (155)

Econ Lecture 37 (March 4).docx

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James Pesando

March 4 Review of last class  Introduced monetary policy o Using the money supply to impact AD o Money supply = currency + deposits  Currency banks: controls the money supply o Multiple deposit creation motivated by profits  Central bank: controls the money supply o Currency ( change the reserves at the chartered banks) o Interest rate manipulation (focus of today’s class) Money supply  Money supply (MS) and Money demand (MD) determine the interest rate (i) o The interest rate is conceptually similar to the price of money o MD is often called liquidity preference (LP) multiple choice on final exam  MS is determined by: o The creation and destruction of currency by the Bank of Canada (BoC) o Multiple deposit creation by charted banks  Loans earn interest and thus create profits for bank  M determined by: (a) price level (b)income level (c) interest rate opportunity cost for money  Suppose households hold 2 assets: Money (currency + deposits) pay no interest Bonds pay the market interest rate  Would you increase or decrease your money holdings if: (a) prices in the economy increase? Increase because the dollar volume of transactions increase (b)your income rises? Real GDP rises Increase because the real volume of transactions increase (c) the interest rates rises from 3% to 18%? Interest is the opportunity cost of holding money (foregone earnings) Falls because the cost of money has increased March 4 Money Demand When all else is equal: a) price level changes shift MD b) income level changes shift MD c) interest rate changes are movements along MD If P or Y increase, MD shifts to the right Bonds How does i act as the opportunity cost of money?  The simplest bond is a single payment one year bond o Buy a bond today, receive a fixed coupon payment in one year o The price of the bond is its present value o PV = (coupon payment in one year) / (1+i) o If the bond price < PV  People
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