Matakuliah
Tahun
: J0594-Teori Ekonomi
: 2009
INTEREST RATE AND MONETARY POLICY
Pertemuan 11
Interest Rates
Defined as the Price Paid for the Use of
Money
Demand for Money
Transactions Demand, D1
Asset Demand, D2
Total Money Demand, Dm
…Graphically
Bina Nusantara University
3
Interest Rates
Demand for Money and the Money Market
Rate of Interest, I percent
(a)
Transactions
Demand for
Money, Dt
(b)
Asset
Demand for
Money, Da
(c)
Total
Demand for
Money, Dm
And Supply
10
Sm
7.5
=5
+
5
2.5
Dt
50
Bina Nusantara University
100
Dm
Da
0
150
200
Amount of Money
Demanded
(Billions of Dollars)
50
100
150
200
Amount of Money
Demanded
(Billions of Dollars)
50
100
150
200
250
300
Amount of Money
Demanded and Supplied
(Billions of Dollars)
4
Interest Rates
• Equilibrium Interest Rate
• Interest Rates and Bond Prices
– Bond Prices Fall When Interest Rates
Rise
– Bond Prices Rise When Interest Rates
Fall
– Inverse Relationship Between Interest
Rates and Bond Prices
Bina Nusantara University
5
Tools of Monetary Policy
• Open Market Operations
– Buying Securities
• From Commercial Banks
• From the Public
– Selling Securities
• To Commercial Banks
• To the Public
• When the Fed Sells Securities,
Commercial Bank Reserves are Reduced
Bina Nusantara University
6
Tools of Monetary Policy
Fed Buys $1,000 Bond from a
Commercial Bank
New Reserves
$1000
$1000
Excess
Reserves
$5000
Bank System Lending
Bina Nusantara University
7
Total Increase in the Money Supply, ($5,000)
Tools of Monetary Policy
Fed Buys $1,000 Bond from the Public
Check is Deposited
New Reserves
$1000
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
Reserves
$1000
Initial
Checkable
Deposit
Bina Nusantara University
8
Total Increase in the Money Supply, ($5000)
Tools of Monetary Policy
• The Reserve Ratio
– Raising the Reserve Ratio
– Lowering the Reserve Ratio
• The Discount Rate
– Borrowing from the Fed by Banks
Increases Reserves and Enhances
Lending Ability
• Relative Importance of Each
Bina Nusantara University
9
Monetary Policy
(a)
(b)
(c)
The Market
For Money
Investment
Demand
Equilibrium Real
GDP and the
Price Level
Sm1
Sm2
Sm3
AS
10
P3
Price Level
Rate of Interest, i (Percent)
Monetary Policy and Equilibrium GDP
8
AD3
I=$25
P2
Dm
6
$25
AD2
I=$20
ID
AD1
I=$15
0
$125
$150
$175
Amount of Money
Demanded and Supplied
(Billions of Dollars)
Bina Nusantara University
$15
$20
$25
Amount of Investment, I
(Billions of Dollars)
Q1
Qf Q3
Real Domestic Product, GDP
(Billions of Dollars)
10
Monetary Policy
•
•
•
•
•
Cause-Effect Chain
Market for Money
Investment
Equilibrium GDP
Effects of an Expansionary Monetary
Policy
• Effects of a Restrictive Monetary Policy
Bina Nusantara University
11
Monetary Policy
Expansionary Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Unemployment and Recession
Fed Buys Bonds, Lowers Reserve
Ratio, or Lowers the Discount Rate
Excess Reserves Increase
Federal Funds Rate Falls
Money Supply Rises
Interest Rate Falls
Investment Spending Increases
Aggregate Demand Increases
Bina Nusantara University
12
Real GDP Rises
Monetary Policy
Restrictive Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Inflation
Fed Sells Bonds, Increases Reserve
Ratio, or Increases the Discount Rate
Excess Reserves Decrease
Federal Funds Rate Rises
Money Supply Falls
Interest Rate Rises
Investment Spending Decreases
Aggregate Demand Decreases
Bina Nusantara University
13
Inflation Declines