Transcript M04d_App4_MishkinEakins3427056_08_FMI_C04

Chapter 4
Appendix 4
Supply and
Demand in
the Market for
Money:
The Liquidity
Preference
Framework
Liquidity Preference Framework
• Economy with two assets:
─ Money (M) – earns no interest
─ Bonds (B) – earn a fixed interest rate
• Supply and Demand for each:
Bs – Bd = Md - Ms
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Liquidity Preference Framework
• Money supplied is assumed fixed
• Figure 1 shows quantity of money
demanded, holding all other variables
(income and price levels) constant.
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Liquidity Preference Framework
Figure 1 Equilibrium in the Market for Money
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Changes in Equilibrium
Interest Rates
• Shifts in the Demand for Money
─ Income effect – higher income increases
demand
─ Price-Level effect – higher prices increase
demand
• Shifts in the Supply of Money
─ Increase in Ms will shift supply curve to the right
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Changes in Interest Rates
Due to Other Factors
Table 1 Summary Factors That Shift the Demand for and
Supply of Money
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Changes in Interest Rates
Due to Changes in Income
Figure 2 Response to a Change in Income
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Changes in Interest Rates
Due to Changes in Price Level
Figure 3 Response to a Change in the Price Level
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Changes in Interest Rates
Due to Changes in Ms
Figure 4 Response to a Change in the Money Supply
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4-8
Are Money and Interest Rates
Negatively Related?
• Last Figure seems to suggest that.
• We have seen the equilibrium effect of
increases in other variables from an
increase in the money supply:
─ income effect: rise in interest rates
─ price-level effect: rise in interest rates
─ excepted-inflation effect: rise in interest rates
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Are Money and Interest Rates
Negatively Related?
• Analysis is a bit more complicated!
─ price-level effect will develop as prices increase
─ inflation-effect ends as price-levels peak
• We can now put all the effects together
depending on which effect dominates
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Responses to
Money Supply Growth (a)
Figure 5 Response over Time to an Increase in Money
Supply Growth
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Responses to
Money Supply Growth (b)
Figure 5 Response over Time to an Increase in Money
Supply Growth
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Responses to
Money Supply Growth (c)
Figure 5 Response over Time to an Increase in Money
Supply Growth
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Are Money and Interest Rates
Negatively Related?
• Which scenario is correct?
• A look at the actual movements of interest
rates and money growth can offer some
insight.
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Money Growth and
Interest Rates
Figure 6 Money Growth (M2, Annual Rate) and Interest Rates
(Three-Month Treasury Bills), 1950–2013
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Are Money and Interest Rates
Negatively Related?
• What does Figure 6 tell us?
─ Figure 5 (a) is unlikely, money supply growth is
usually accompanied by expected inflation
─ Can’t really say much about Figure 5 (b) or (c).
Depends on expectations.
• Recent research does suggest that
increased money growth temporarily lowers
short-term interest rates.
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