Please enable JavaScript.
Coggle requires JavaScript to display documents.
The Money Market & Interest Rate Determination (Keynesian Liquidity…
The Money Market & Interest Rate Determination
The central bank
is an institution designed to oversee the banking system and regulate the quantity of money in the economy
Whenever an economy relies on fiat money, there must be some agency that regulates the system.
The
money supply
is the quantity of money available in the economy.
The regulation of the money supply is a crucially important task.
Monetary policy
is the set of actions taken by the central bank in order to affect the money supply.
THE EUROPEAN CENTRAL BANK AND THE EUROSYSTEM
The European Central Bank is the overall central bank of the 19 countries comprising the European Monetary Union.
The ECB was officially created on 1 June 1998 and is located in Frankfurt.
It came into being because 11 countries of the European Union had decided that they wished to enter European Monetary Union and have the same currency circulate among them.
The Eurozone
To enter, countries had to meet certain criteria relating to inflation, interest rates, government borrowing and national debt.
Initial Member countries (11): Austria, Belgium, France, Finland, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain.
2001 Greece joined; 2007 Slovenia and 2008 Malta and Cyprus; Slovakia 2009, Estonia, 2011, Latvia 2014.
19 Eurozone countries
UK, Sweden and Denmark decided to stay out.
THE EUROPEAN CENTRAL BANK AND THE EUROSYSTEM
The primary objective of the ECB is to promote price stability throughout the euro area.
An important feature of the ECB and the Eurosystem is its independence.
The
Eurosystem
is the system made up of the ECB plus the national central banks of the 19 countries comprising the European Monetary Union.
Quantity Theory
This states that the larger the quantity of money in the economy, the higher the price level
MS x V =P x Real GDP
Keynesian Liquidity Preference Theory: Money Demand
Three Reasons for Holding Cash
Transaction Motive
Precautionary Motive
Speculative Motive
Transaction and Precautionary Motive
MD = f( Price, Real GDP)
Speculative Motive
‘ with the object of securing profit from knowing better than the market what the future will bring forth’
There is an inverse relationship between MD and interest rates
MD= f ( r)
Combining Keynes three reasons for holding money, then the demand for money is given by:
Md = f (P, Real GDP, r)
The Central Bank may influence the size of the money supply through
: Open Market Operations. Changes in Interest Rates. Changes in Reserve Ratios.
Open Market operations.
buying and selling of government stock on the open market to influence the money supply. If CB buys gov stock : increase in MS. If CB sells gov stock: decrease in the MS Setting Reserve
Requirement: Increase RR
: decrease in the MS. Decrease in the RR: increase in the MS
Changes in Interest Rate
: rate at which the CB lends to the commercial banks ( main refinancing interest rate (MRIR). increase interest rate: decrease in MS. decrease interest rate: increase in MS