Money Market (Supply & Demand for Money)
- Demand for money has inverse relationship between nominal interest and quantity of money demanded.
What happens to the quantity demanded of money when interest rates increase?
- Quantity demanded falls because individuals would prefer to have interest carrying assets instead of borrowed liabilities.
What happens to the quantity demanded when interest rates decrease?
- Quantity demanded increases.
What is Money Demand?
- Change in price level
- Change in income
- Change in taxation that affects investment
What happens in Money Supply?
- If FED increases the money supply, a temporary surplus of money will occur at a 5% interest. The surplus will cause the interest to fall to 3%.
- Demand deposits are created through the fractional reserved system
What is the fractional reserve system?
- It is the process in which banks hold a small portion of their deposits in reserves and they loan out the excess
What is a Required Reserve?
- It is cash that bank keeps on hand
What is total reserve/actual reserve?
- TR or AR = RR + ER
- RR - required reserves
- ER - excess reserves (loans)
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