BONUS!!!

What decade were ATMs
introduced in the US?
Mods 28 and 29
MM and LF

MM and LF (29)

A. Loanable Funds Market and the Money Market
1. Reminder and Review
a. Savings-Investment Spending Identity
S=I
b. This includes government and private
savings!
National Savings (Pub. and Priv.)= I
2. Through financial markets, borrowers and
lenders are matched.
MM

 Opportunity cost to holding cash money – not making
any interest on it

interest rate (r),
quantity of money demanded

interest rate (r),
quantity of money demanded
 Short term interest rates tend to move together, they are
competition for each other
 Long-term interest rates change much slower because
they take longer to mature
 EASIEST to assume only the short-term
MM

 Money demand curve – relationship between
quantity of money demanded and r
 Use the nominal r for this because the purchasing
power of your money is caused by inflation so you
need to look at money value now
 Shifts of money demand




Changes in Aggregate Price Level
Changes in real GDP
Changes in Technology
Changes in Institutions
MM and the Fed

 Fed can influence the money supply (through the
monetary supply but it can still be done)
 Fed able to choose the
level they want and use
open operations to get
there
MM and LF (29)

B. Loanable Funds Market and the Interest Rate
1. In the real world, MANY different financial
markets with many different interest rates,
however, to simplify, economists created a
hypothetical market.
2. Loanable Funds Market
a. Nominal vs. Real interest rates
Incredibly important to the MM and
LF market!
MM and LF (29)

3. How does a spender (firm or business) decide
how much to borrow?
a. Rate of Return
pg. 278
RofR= Revenue of Proj-Cost of Proj X 100
Cost of Proj.
4. Demand and Supply of Loanable funds
a. based on interest rates, government
influence
b. Interest Rate = Price of a loan

MM and LF (29)

5. Shifts of Demand for Loanable Funds
a. Changes in Perceived Business
Opportunities (1990s investment boom)
b. Changes in government borrowing
1. Crowding Out
*When a government needs
to borrow money (run a
deficit), this increases the
demand for loanable funds
*In turn, this leads to higher
interest rates.
*If rates rise, businesses cut
back in investment spending
MM and LF (29)

6. Shifts in Supply of Loanable Funds
savings)
left.
a. Changes in Private sector behavior (private
2000-2006- More spending, less saving, SLF shifts
b. Changes in
Capital Inflow
(open economy)
MM and LF (29)

C. Interest Rates and Inflation
1. Inflation is arguably the most important factor
affecting interest rates
a. Real and Nominal rates
Real= Nominal – Inflation
2. Expected inflation vs. Unexpected inflation
3. Fisher Effect
a. The expected future real interest rate is
unaffected by the change in expected
future inflation!
1% of expected inflation = 1% of
nom interest rate… SO…real = unchanged

MM and LF (29)

4. Interest Rates in the Short Run
a. Money Market and LFM relate to each
other through interest rates.
b. If one is at equilibrium so is the other
(causal relationship)
1. This is always true!!! (pg. 285)
b. EXAMPLE
What happens to LFM when a shift
occurs in the MM?
Connecting the Two
Interest Rate Models

MM and LF (29)

EX- In the short run, the right ward shift of the
money supply…
- Leads to a rise in real GDP
- Generates a rise in savings through the
multiplier process.
- Rise in savings shifts the supply curve for
LFM rightward, S1 to S2.!!
- Moves equilibrium and reduces the interest
rate in LFM
** In the SHORT RUN, the supply and demand for
money determine the interest rate. The LFM follows
the lead of the MM!!!!!!
MM and LF (29)

5. Long Run?- Changes in MS don’t affect the r%!!
a. In the long run, after an increase in money
supply drops the interest rate…
1. Aggregate Price Levels adjust
by the same proportion as the initial
increase in the money supply
2. In the long run, the money demand
curve shifts outward, returning
interest rates to their original level.
b. In the LFM, the supply curve shifts right,
but falls back in the long run as real GDP falls
back to original level due to wages and other
nominal prices increases over the long run!!!

Debt and Deficit Articles

Read your assigned article!
Be sure to note the following:
Key points by the author
Suggested course for the “Fiscal Cliff”
Political critiques (opinions on Repubs and
Dems)
Write down a quote you find relevant and
be prepared to discuss.