Questions on interest rates affecting demand of money
I’m confused as to what kind of interest rate is at play here? This is the interest rate for securities right?
“The relation between short-term interest rates and the quantity of money that firms and households demand to hold is illustrated in Figure 18.1. At lower interest rates, firms and households choose to hold more money. At higher interest rates, the opportunity cost of holding money increases, and firms and households will desire to hold less money and more interest-bearing financial assets. (Eaton 109, Kaplan Schweser book 2 economics)”
But now the confusion begins. See below on how monetary policies policy rate changes affect short term lending rates etc.
“There are four channels through which a change in the policy rates the monetary authorities control directly are transmitted to prices. They are transmitted through their effect on other short-term rates, asset values, currency exchange rates, and expectations. (Eaton 114-115)
1. Banks’ short-term lending rates will increase in line with the increase in the policy rate. The higher rates will decrease aggregate demand as consumers reduce credit purchases and businesses cut back on investment in new projects.
2. Bond prices, equity prices, and asset prices in general will decrease as the discount rates applied to future expected cash flows are increased. This may have a wealth effect because a decrease in the value of households’ assets may increase the savings rate and decrease consumption.
3. Both consumers and businesses may decrease their expenditures because their expectations for future economic growth decrease.
4. The increase in interest rates may attract foreign investment in debt securities, leading to an appreciation of the domestic currency relative to foreign currencies. An appreciation of the domestic currency increases the foreign currency prices of exports and can reduce demand for the country’s export goods. (Eaton 115)”
1 the short term interest rate is the interest rate of the loan by the bank to customers, right? This is NOT the same rate as the security interest rate affecting demand of money?
2 and 4 I’m confused how discount rates to future cash flow is affected by change in policy rate? How does changes in bank loan interest rate attract foreign investment in debt security? How does it affect currency?
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