Mishkin Money and Banking: CH 5

Factors that shift the DEMAND CURVE:

1) Wealth 2) Expected returns on bonds relative to alternative assets 3) Risk of bonds relative to alternative assets 4) Liquidity of bonds relative to alternative assets

4 factors to consider whether buying / holding asset:

1) Wealth 2) expected return 3)risk 4) liquidity

Response to an increase in expected inflation rate: (The Fisher Effect)

1) demand curve shifts left 2) supply curve shifts right 3) price of bond falls, interest rate will rise

factors that cause supply curve for bonds to shift:

1) expected profitability of investment opportunities 2) expected inflation 3) government budget deficits

Response to a business cycle expansion:

1) supply curve will shift right 2) demand curve will shift right 3) price of bonds will fall, interest rate will rise

both the supply and demand of bonds to shift to the right

A business cycle expansion causes:

demand curve

A curve depicting the relationship between quantity demanded and price when all other economic variables are held constant

supply curve

A curve depicting the relationship between quantity supplied and price when all other economic variables are held constant

the money demand curve to shift to the left, interest rate falls

A decrease in price level causes:

liquidity preference framework

A model developed by John Maynard Keynes that predicts the equilibrium interest rate on the basis of the supply of and demand for money (rather than the supply and demand for bonds) -assumes that people use 2 main categories of assets to store their wealth: money and bonds -he assumed that money had zero rate of return, and bonds have a return equal to the interest rate -as the interest rate rises: the expected return of money falls relative to the expected return of bonds (causing a fall in the quantity of money demanded) Total Wealth in economy = (total quantity of bonds supplied) + (total quantity of money supplied)

excess supply

A situation in which quantity supplied is greater than quantity demanded

market equilibrium

A situation occurring when the quantity that people are willing to buy (demand) equals the quantity that people are willing to sell (supply)

theory of portfolio choice

A theory of how much of an asset people want to hold in their portfolio, with the amounts determined by wealth, expected returns, risk, and liquidity

wealth

All resources owned by an individual, including all assets

asset market approach

An approach to determine asset prices using stocks of assets rather than flows

decreases demand, shifts left

An increase in the expected return on alternative assets:

Fall

An increase in the money supply (money supply curve shifts right) causes interest rates to:

increases, shifts to the right

For a given interest rate (and bond price) when expected inflation increases, the real cost of borrowing falls, and the supply curve

decreases

Higher expected future interest rates lower the expected return for long-term bonds... what happens to demand?

shift the supply curve to the right; shift the supply curve to the left (decrease the supply of bonds)

Higher government deficits: Government surpluses:

Raise

If the Fed is only concerned about the​ short-run economy the liquidity effect is smaller than the other effects and expected inflation adjusts​ slowly, then to lower the​ short-run interest​ rates, the Fed should always _____________ the growth rates of the money supply.

immediately rise and then fall over​ time, but will remain higher than its original level

If there is a decrease in the growth rate of the money​ supply, the resulting liquidity effect is larger than the combined​ income, price-level, and expected inflation​ effects, and inflationary expectations adjust​ quickly, then the interest rate will

Increases

In a business cycle expansion, the supply of bonds:

increase the growth rate of the money supply

In the long​ run, if the​ output, price-level, and expected inflation effects outweigh the liquidity​ effect, to raise interest rates the Federal Reserve should

decreases, shifts to the left

Increase in expected inflation rate lowers expected return on bonds... what happens to demand?

negatively related

Interest rate and price of a bond are:

Fall

Suppose there is an increase in the growth rate of the money supply. If the liquidity effect is smaller than the​ income, price-level, and expected inflation​ effects, and if inflationary expectations adjust​ slowly, then in the short​ run, interest rates:

fall compared to their initial value

Suppose there is​ a decrease in the growth rate of the money supply. If the liquidity effect is smaller than the​ output, price-level, and expected inflation​ effects, then in the long​ run, interest rates

opportunity cost

The amount of interest (expected return) sacrificed by not holding an alternative asset -the quantity of money demanded and the interest rate should be negatively related -as the interest rate on bonds rises, the opportunity cost of holding money rises, so the quantity demanded of money falls because it is now less desirable

risk

The degree of uncertainty associated With the return on an asset

Fisher effect

The outcome that when expected inflation occurs, interest rates will rise; named after economist Irving Fisher

liquidity

The relative ease and speed with which an asset can be converted into cash

expected return

The return on an asset expected over the next period

decrease

When the Fed wants to reduce the expected​ inflation, it should _____________ the growth rate of the money supply.

supply of bonds will shift right, the interest rate will INCREASE

When the government increases its budget deficit

Income effect:

a higher level of income causes the demand for money at each interest rate to increase, and the demand curve to shift to the right (interest rate will rise)

Supply of money:

completely controlled by the central bank; (the fed) an increase in the money supply engineered by the Federal Reserve will cause a shift of the supply curve for money to the right (interest rate will decline)

Risk

if an assets risk rises relative to that of alternative assets, the quantity demanded will fall

Expected return

increase in expected return relative of that of an alternative asset = raises the quantity demand of that asset

ceteris parabis

other things being equal

Price - Level effect:

people will want to hold a greater nominal amount of money that they hold in real terms (so when the price level rises, they want to restore that value) - effect: a rise in price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right (interest rate will rise)

excess demand

quantity demand is greater than quantity supplied

lower prices of a bond:

quantity demanded is higher, the demand curve has a downward slope

theory of portfolio choice

tells us how much of an asset people will want to hold in their portfolios 1) the quantity demanded of an asset is positively related to wealth 2) quantity demanded is positively related to its expected return 3) negatively related to the risk of its returns relative to alternative assets 4) is positively related to its liquidity relative to alternative assets

Liquidity:

the more liquid an asset is relative to alternative assets, the more desirable it is and the greater the quantity demanded will be

as prices increase (supply curve):

the quantity supplied increases (usual upward slope)

interest rates will rise

when expected inflation rises:

Wealth

when we find that wealth has increased, we have more resources available to purchase assets, so the demand of assets increase (increase in wealth= increase in quantity demanded of asset)