Supply of money and interest rate relationship

Demand, Supply, and Equilibrium in the Money Market

supply of money and interest rate relationship

circulates in an economy, the money supply? • Central banks Expected returns/ interest rate on money relative . In the long run, there is a direct relationship. Nov 1, How Money Supply and Demand Determine Nominal Interest Rates as the relationship between the interest rate and quantity of money. An increase in the money supply will lead to in increase in the amount of money that people Money demand for money and interest rate are inversely related.

Their borrowing it for a reason. Their either going to borrow to consume to buy something that they always wanted that they think will make them happy, or more likely their borrowing it to invest it and hopefully getting a return higher than what they are borrowing at.

supply of money and interest rate relationship

You have a marginal benefit curve that would be downward sloping something like that. Maybe it looks something like that. That is our demand curve or our marginal benefit curve. Now, once again this is the exact same logic we use with the demand and supply curve for any good or service.

Money supply and demand impacting interest rates - Macroeconomics - Khan Academy

For money might look like this. Those first few dollars someone has a very low opportunity cost of lending it out, so, their willing to lend it out at a very low interest rate. Then every incremental dollar after that theirs higher opportunity cost, and people will lend it out at a higher and higher rate.

Then you have a market equilibrium interest rate. Let me copy and paste this.

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Then we could think about what happens in different scenarios. Now we have 2 scenarios that we can work on, and then let me just do 1 more. Let's think of a couple. Let's say that the central bank of our country, in the United States, that would be the Federal Reserve, the central bank prints more money.

Then decides to lend out that money. It is disturbed when central banks print money. The way that it enters into circulation in most countries is that the central bank then goes and essentially lends that money.

supply of money and interest rate relationship

The way it's done in the US Fed, most part they go out and buy government securities which is essentially lending money to the Federal Government. They do that because that's considered to be the safest investment. They go out there and they lend money. If this is our original supply curve.

If this is our original supply curve, but now your Federal Central Bank is printing more money and lending it out. What is going to happen over here?

Money supply and demand impacting interest rates (video) | Khan Academy

Your supply curve is going to shift to the right at any given price, at any given interest rate. Your going to have a larger quantity of money being available. It might look something like Assuming that's the only change that happens you see its effect. Your new equilibrium price of money, the rent on money, or the interest rate on money is now lower. That's why when the Federal Reserves say I want to lower interest rates, they do so by printing money.

They print that money, and they lend it out in the market.

Money supply and demand impacting interest rates

That essentially has the effect of lowering interest rates. Let's think about another situation. Let's say this is the Fed prints and lends money. Their lending the money by buying government bonds. When you buy a government bond, your essentially lending that money to the Federal Government. I've done other videos on that where we go into a little bit more detail on that.

supply of money and interest rate relationship

Let's think of another situation. Let's think about consumer savings go down. One interesting thing about savings, savings and investment are two opposite sides of the same coin. When you save money You have the whole financial system right over here. This is the finincial system. That money goes out and is lent to other people. For the most part, hopefully, that money when it's lent is used to invest in someway.

Transactions demand for money: If the transaction is very high then the quantity of money demanded for transaction is high too. It is also a store of value. There are two ways in which people can store their purchasing power in the form of money in the form of other financial assets such as private and government securities Precautionary demand for money: The precautionary demand for money varies directly with nominal national income and inversely with the interest rate.

Asset demand or Speculative demand for money: This kind of demand for money people wishes to hold because of its liquidity and lack of risk. The asset demand for money varies inversely with the interest rate. Money demand for money and interest rate are inversely related The demand for money slopes downward because as interest rate declines, the opportunity cost of holding money will decline too.

Therefore, the quantity of money demanded will increase. The effects of an increase in the money supply: When the money supply increases, people will have excess money to spend and two things can happen Direct effect of an increase in the money supply: That is some people will demand more goods and services. Indirect effect of an increase in the money supply: Therefore, excess reserves will increase and banks will want to lend more. Banks will lower interest rate to motivate borrowing.