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Chapter 3

Study guide - Chapter 3 - Money, Interest Rate, and Exchange Rates

5 Pages

Course Code
ECON 345
David Cox

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Money, Interest Rates, and Exchange Rates Exchange rate bw currencies depends on 2 factors o Interest rate earned on deposits o Expected future exchange rate Explain effects of money supply and money demand on its interest rate and exchange rate Monetary developments influence the E both by changing the interest rates + by changing ppls expectations about future exchange rates Expectations of future exchange rates depend on many factors other than money Money Demand: A Brief Review Medium of exchange generally accepted means of payment, no more barter system Unit of Account widely recognized measure of value, comparable terms, relative prices Store of Value transfer purchasing power f present into future What is Money? Money supply monetary aggregate the Fed Reserve calls M1 total amt of currency + checking deposits held by households + firms How the money supply is determined Controlled by central bank Demand for Money by Individuals Can be derived from the theory of asset demand Base demand on 3 characteristics o Expected return the asset offers compared w the returns offered by other assets o Riskiness of the assets expected return o Assets liquidity o *households hold money only bc of its liquidity, so liquidity matters (unlike FX market) Expected Return Currency pays NO interest opportunity cost when holding money Other things equal, ppl prefer assets offering higher expected returns a rise in interest rate causes demand for money to fall Risk Risk is NOT important in money demand Any change in riskiness of money = change in riskiness of bonds Liquidity Main benefit of holding money Rise in avg value of transactions carried out by a household or firm causes its demand for money to rise Aggregate Money Demand The total demand for money by all households + firms in economy sum of all economys individual money demands 1) Interest rate rise in interest rate = reduce aggregate money demand 2) Price level higher price level = increase aggregate money demand 3) Real national income GNP rises = more goods sold in economy = increase aggregate money demand (given the price level) www.notesolution.com
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