Interest rate determination
Money supply and interest rates
Meaning and Objectives of Monetary Policy
Specific tools of Monetary policy
-open market operations
-Bank rate
-Swiching government deposits
-moral suasion
Tree reasons for holding money : (transactions purpose, precautionary purposes, speculative purposes)
Transactions demand for money- to desire to hold money for transaction purposes.
the transactions demand for money varies directly with the level of income.
Precautionary demand for money- the desire to hold money for unexpected contingencies( broken furnace, a blown muffler, a really big sale at a major department store)
THE precautionary DEMAND FOR MONEY VARIES DIRECTLY WITH THE LEVEL OF INCOME
Speculative demand for money – the desire to hold money in anticipation of movements in the prices of financial assets.
If interest rates are high(bond prices are low) and people expect them to fall(bonds prices to rise) they will buy bonds now, hoping to sell them for future profit.
THE SPECULATIVE DEMAND FOR MONEY IS INVERSELY RELATED TO THE RATE OF INTEREST.
THE ASSET DEMAND FOR MONEY IS INVERSELY RELATED TO THE INTEREST RATE
Liquidity preference- the desire to hold money rather than less liquid interest-earning assets.
Liquidity preference curve- the curve showing the inverse relationship between the quantity of money and the rate of interest.
OTHER THINGS BEING EQUAL, AN INCREASE IN INCOME CAUSES THE DEMAND CURVE FOR MONEY TO SHIFT TO THE RIGHT, A DECREASE IN INCOME CAUSES THE CURVE TO SHIFT TO THE LEFT.
Money supply- the total quantity of money supplied at various rate of interest.
OTHER THINGS BEING EQUAL, AN INCREASE IN THE DEMAND FRO MONEY WILL RESULT IN AN INCREASE IN THE REATE OF INTEREST.
OTHER THINGS BEING EQUAL, A DECREASE IN THE DEMAND FOR MONEY WILL RESULT IN A DECREASE IN THE REATE OF INTEREST.
OTHER THINGS BEING EQUAL,, AN INCREASE IN THE MONEY SUPPLY WILL RESULT IN A FALL IN THE RATE OF INTEREST.
OTHER THINGS BEING EQUAL, A REDUCTION IN THE SUPPLY OF MONEY WILL RESLT IN AN INCREASE IN THE RATE OF INTEREST.
Monetary policy- refers to the activities of the central bank designed to bring about changes in the money supply, the availability of credit, and the level of the interest rates in order to influence general economic activities.
CHANGING IN THE MONEY SUPPLY AND INTEREST RATES DO NOT CONSTITUTE MONETARY POLICY UNLESS THEY HAVE BEEN INITIATED BY THE BANK OF CANADA.
OBJECTIVES OF MONETARY POLICY:
full employment
price stability
maximum growth of real output
equilibrium balance of payments
THE SPECIFIC TOOLS FOR IMPLEMENTING MONETARY POLICY:
Open market operation
-the buying and selling of securities (bonds) by the central bank. Affects not only on money supply but also interest rates. More security purchased- interest rates will fall.
Central bank advances and the bank rate
Bank rate- the rate of interest that the central banks charges on loans and advances to members of the Canadian Payments Association. Bank rates rises, lending institutions raise their lending rates. Bank rates fall, they lower their lending rates and also make credit more easily available.