Money Market v. Loanable Funds
* Nominal v. Real Interest Rates
* When the FED Manipulates Loanable Funds… It is really working through another “MARKET” –
known as the “MONEY MARKET”
*The Money Market – Sets the “Nominal” Interest Rates – (Product of the Federal Funds Rate Target)
Nominal
i
Sm
Dm
Money Supply
In terms of the AP Test…
What is the Sm?
Money Available Set by the FED
What is the Dm?
How much of your “wealth” do you wish to keep in the form
of money (M1) - Currency and Bank deposits
What Shifts “Sm” ?
What Shifts “Dm”?
FED’s Monetary Policy
*Transaction Demand for Money as determined by Price
Levels (Nominal GDP ) - when the price level rises more
money is needed to make a given transaction, so people tend
to increase their holdings of money when the price level rises.
*Level of Real Income: when individuals have more income
they tend to hold more money as a store of value and to carry
out more transactions using money.
Does the Slope of the Dm Curve Matter?...
YES…. It Reflects the Asset Demand for Money
SO…When the FED alters the Money Supply, it is also changing the “Loanable Funds” available in the
Banking System. This will change Interest Rates, the amount of Bank Loans in the Economy, the overall
amount of Aggregate Demand/Total Spending, and therefore the GDP and the Business Cycle…. So the
Graph Sequence of Monetary Policy Looks like this…
i
The Graphs reflect very similar concepts, but the “question” guide when determining which graph to use….
Basically….
* The Money Market Graph is used when…
1) The focus is on Monetary Policy Directly …
2) There is a connection to Transaction Demand for Money among the public – usually the result of
Price Changes reflected by a change in NOMINAL GDP….
* The Loanable Funds Graph is used when…
1) There is a change in the SUPPLY of Loanable Funds FOR ANY REASON
2) There is a change in the level of BORROWING from ANY SOURCE