Slide 2:
Demand for Money Individuals and firms tend to hold a variety of financial assets These can be divided into Financial assets - cash, bank accounts, shares etc Physical assets - property, consumer durables, arts and fine wines The demand for holding money is determined by two key factors Income - the higher the level of income the greater the demand for money in order to spend The rate of interest - money could be used to buy financial assets such as bonds which yield interest. The higher the rate of interest, the higher the opportunity cost of holding the money This diagrams shows the relationship between interest rates and the demand for money and also the impact of a change in income The demand curve slopes downwards because a rise in the rate of interest increases the incentive to hold interest bearing financial assets such as bonds A rise in income will shift the demand for money curve to the right at any given rate of interest - more spending needs more money The interest rate is the price of holding money
Slide 3:
The rate of interest This diagram shows the demand and supply curves for money It is usual to draw the money supply as a vertical line We assume that a central bank such as the BoE can control the supply of money in the economy independently of the price The equilibrium rate of interest is at re where the demand for money equals the supply of money The interest rate is the price of holding money
Slide 4:
The rate of interest If the demand for money increases for example due to an increase in income more money will be demanded This will shift the curve to the right The equilibrium rate of interest will increase from r1 to r2 A fall in demand for money will lead to a fall in the rate of interest The interest rate is the price of holding money
Slide 5:
The rate of interest If the government or central bank increases the money supply the MS curve will shift rightwards as shown in this diagram This will lead to a fall in interest rates from r1 to r2 A reduction in the money supply would have the opposite effect and increase the interest rate The interest rate is the price of holding money
Slide 6:
The rate of interest We have so far assumed that there is only one market for money and thus one equilibrium rate of interest In reality there are many money markets and different rates of interest Rates of interest for government bonds differ from those of credit cards and mortgages However, interest rates should tend to move in the same direction If the BoE cuts the base rate we would expect to see lower
mortgage rates and lower rates on savings accounts With the effects of the recent credit crunch this link has been slow to materialise When banks face difficulties they tend to be more reluctant to pass on lower interest rates It is also worth pointing out the difference between nominal and real interest rates Real interest rates are adjusted for
inflation and is more important for businesses and consumers Base rate : The interest rate the central bank sets to determine its lending and borrowing rates Credit crunch : refers to the unwillingness of financial institutions to lend to households and one another