Equilibrium Income • Keynesian Approach: AE d determines Y (income/output) produced • Can there be limitations to this link? YES because interest rates and/or prices might change that will reduce the effect on Y.
Dec 14, 2015
Equilibrium Income
• Keynesian Approach: AEd determines Y (income/output) produced
• Can there be limitations to this link?YES because interest rates and/or prices
might change that will reduce the effect on Y.
Interest Rates
• Interest rates are determined by the supply and demand of loanable funds.
• Let’s take a closer look at this market.Money
MarketFinancial MarketBond Market
Equities Market
Money Market
• What is money?
Historical Development of Money
• No Money: Barter Economy (goods for goods)• Money as a medium of Exchange:
Goods Money Goods
• How did all start?– Precious metals,– Paper money backed by gold,– Paper money fractionally backed by gold,– Fiat money,
Properties of a Good Medium of Exchange
1. Acceptable2. Standardized quality3. Durable4. Valuable relative to its weight5. Divisible
The Functions of Money
1) Medium of Exchange2) Unit of account3) Store of Value4) Standard of deferred payments
Money Supply Today
• Money supply (M1)Currency (in circulation) + demand deposits (TL and Foreign Currency)
• Money supply (M2)M1 + Time deposits (TL and Foreign Currency)
M1 and M2 in Turkey
2005 2006 2007 2008 2009 2010 2011 20120
100000000
200000000
300000000
400000000
500000000
600000000
700000000
800000000
M1M2
US Money Supply
Nov. Dec. Jan. 2011
Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. 2012
Feb. Mar. Apr. May June July Aug. Sep. Oct.0
2000
4000
6000
8000
10000
12000
M1M2
Can the Central Bank change MS?
• YES!!!
• HOW? – With some tools known as monetary policy tools.
(Tools are instruments that a policy maker can change in order to influence the workings of an economy)
Monetary Policy Tools
1. Discount Rate,2. Reserve Requirement ratio,3. Open Market Operations.
How do they work? Need to look at how banking system work and money changes hands…
Commercial Banks
• Banks are profit seeking institutions.– They accept deposits,– They give loans
• Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti
…)
Commercial Banks Balance SheetsAssets Liabilities
Reserves Deposits
Loans Short and long term borrowing
Building and Equipment Other Liabilities
Other Assets
Total Liabilities
Stock holders equities
Total Assets Total liabilities + stock holders’ equities
Rules that commercial banks follow:
• Hold the required reserve ratio determined by Central Bank.
If required reserve ratio (rr) is 15%, then in equilibrium
(Reserves/ Deposits)*100 ratio=15 %.
e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL.
(Reserves/ Deposits)*100 ratio=(300/2000)*100=15 %
A new deposit comes into Bank One
Change Assets Change LiabilitiesReserves +1000 Deposits +1000
Loans
Total Assets +1000 Total Liabilities +1000
Bank One uses this new deposits in giving out new loans
(Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850.
Change Assets Change Liabilities
Reserves + 150 Deposits +1000
Loans + 850
Total Assets +1000 Total Liabilities +1000
The new loan comes back to Bank Two Change Assets Change LiabilitiesReserves +850 Deposits +850
Loans
Total Assets +850 Total Liabilities +850
Change Assets Change LiabilitiesReserves +127.5 (850*0.15) Deposits +850
Loans +722.5 (850*0.85)
Total Assets +850 Total Liabilities +850
New loans of 722.5 TL are created by Bank Two
This will repeat ∞ times
• Total change in the deposits: 1000+ (0.85*1000)+(0.85*1000)2+(0.85*1000)3+…
(0.85*1000)∞=
• Total change =
• Change in total deposits=
Money supply
• Money market • Tools to increase the MS1) Discount rate increase,2) Reserve requirement
ratio decrease,3) Open Market
Operations (Buy bonds)
I
Q of money
Money demand
• Money market • Types of Money demand
1) Transaction demand,2) Speculative demand,3) Precautionary
demand,
• MD= L(Y, i) or• MD= 5*Y – 3*i
I
Q of money
Money demand
• Money market • If Y increases, then MD curve shifts to the right
• MD= L(Y, i) or• MD= 5*Y – 3*i
I
Q of money
Money market equilibrium
• Money market MS=MD
• Money supplyMS= 1000
• Money demandMD= L(Y, i) orMD= 5*Y – 3*I
(For a given Y level you will be able to determine equilibrium interest rate)
I
Q of money