Has anyone noticed that the CFAI books state that the Fed influences the “quanitity of money” as opposed to the “supply of money.” When they refer to the quantity of money, do they really mean the supply of money? Or are they referring to the quantity of money after the demand for money has been affected?
Fed effects the supply of money. Interest rates however are only influenced by demand.
money supply= quantity of money in circulation injected by the Fed
When the fed decreases the supply of money, it means banks have less money to loan. The supply of money curve shifts to the left. As a result, interest rates increase. When interest rates increase, the demand for money decreases (movement and not a shift). The result is equilibrium. Therefore, it is incorrect to say that demand influences interest rates? Would it be correct to say that interest rates influence demand?
This is like the egg and the chicken, who was first?
map1 Wrote: ------------------------------------------------------- > This is like the egg and the chicken, who was > first? Fed is focused on supply!
That depends:) they could be focused on price stability (McCallum) or price stability and GDP (Taylor) true, targeting money supply (McCallum) or fed funds rate (Taylor)
So, is my analysis correct or incorrect? Does money supply affect interest rates which in turn affect demand? Or does money supply affect money demand which in turn affects interest rates?
“Therefore, it is incorrect to say that demand influences interest rates? Would it be correct to say that interest rates influence demand?” I got a Schweser Qbank question wrong last night (and cursed!). If someone has a book handy can they look it up quick? Fed influences supply, and demand influences interest rates was the way the explaination came out I believe.
Hey guys, have a look at this presentation. http://www.wcc.hawaii.edu/facstaff/briggs-p/Macroeconomics/Chap_34_MonetaryFiscal.ppt
Money supply is the prerogative of the Feds, and simply the demand for money is not enough of a reason to make the Fed increase the quantity supplied. Just because I think I need more money to finance my operations is not a good enough reason for the feds to pump some money in the market. Depending on what the Feds are targeting, or are focused on, money supply can stimulate or contract agregate demand. But the first effect of an increase in money supply I would say it is the decrease in interest rates. First the money go to banks, which have excess reserves, and banks are willingly offering larger amounts of loanable funds, a lower rates (because banks have excess reserves). That in turn stimulates demand.
And then, at increasing demand, just like for any other good, the price of moeny goes up.
The reason I got the question wrong was I answered fed’s actions control supply and demnd both. Demand is independent of the fed’s actions and is adjusted by the rate of interest. Help me out here…
Feds don’t control demand, but they can influence it by manipulating the interest rates. Say rates go down, can the Feds make you consume more money just because rates are down? Or, say the Fed makes rates go up to contract AD, if you’re company would die without a loan to cover your short term liabilities, would the increased interest rates stop you from going for a loan?
map1 Wrote: ------------------------------------------------------- > Feds don’t control demand, but they can influence > it by manipulating the interest rates. Say rates > go down, can the Feds make you consume more money > just because rates are down? Or, say the Fed makes > rates go up to contract AD, if you’re company > would die without a loan to cover your short term > liabilities, would that stop you from going for a > loan? This is the way i look at it: The Fed controls the money supply in three ways: - First, it sets the “reserve requirement” for all banks. Thus, the Fed can shrink the money supply by requiring banks to hold more in reserve, which pulls money out of the system. Of course, Fed governors can also expand the supply by lowering reserve requirements. - The second way the Fed controls the money supply is through the buying and selling of Treasury bills and notes. - Finally, the Fed moderates the money supply through raising or lowering interest rates.
Yeap, these are the 3 ways Feds can control supply of money: reserves, open market operations, discount rate. Feds don’t control demand, but they can influence it.
map1 Wrote: ------------------------------------------------------- > Yeap, these are the 3 ways Feds can control supply > of money: reserves, open market operations, > discount rate. > > Feds don’t control demand, but they can influence > it. Yep this is clear. Thanks map!
> Therefore, it is incorrect to say that demand influences interest rates? Would it be correct to say that interest I think you are mixing aggregate demand (AD) and demand for money. If money supply is cut, interest rates rise, and AD decreases leading to a recession. And yes, AD influences interest rates because as AD increases, prices go up (inflation). Then in order to combat inflation, interest rates are raised, which cuts demand and return economy to equilibrium, etc.
Greenspan is (was) god!!!
The main operating tool is the FED rate, and not the supply of money. FED rate = interest rate, is how FED keeps inflation in check. That is the main focus of all FED actions = stable price level. Supply of money, conducted through FOMC is a secondary tool. It just happens that FOMC actions are in the headlines now since they are primary tool in combating credit crunch.