Exam 11: Money Demand and the Equilibrium Interest Rate

What is commercial paper and upon what does the interest rate depend?

Assume that Joe earns $2400 a month, deposits it in a checking account and draws down his income evenly throughout the course of the month with an average money holding of $1200. What are the costs of this money strategy?

How can the Fed affect future short-term interest rates through expectations?

Explain the demand for money in relation to interest rates.

How do changes in interest rates affect the composition of bonds and money that people will want to hold?

Graphically demonstrate the effect on the equilibrium interest rate of an increase in the money supply by the Fed.

If interest rates are currently at zero percent how might this inhibit the ability of the Feederal Reserve to conduct monetary policy to stimulate investment?

Explain the effect of a reduction in the price level on the demand for money and the interest rate.

Keynes argued that people hold money for speculative reason. He stressed the choice between money and bonds. If agents expect the future nominal interest rate (the return on bonds) to be lower than the current rate they will then reduce their holdings of money and increase their holdings of bonds. If the future interest rate does fall, then the price of bonds will increase and the agents will have realized a capital gain on the bonds they purchased. This means that the demand for money in any period will depend on both the current nominal interest rate and the expected future interest rate. What implications does this have with respect to the volatility of money?

One rationale for holding money is the transaction motive. Explain what this means.

Mary earns a monthly income of $3,000. She spends the entire amount each month at the rate of $100 a day. (Assume there are 30 days in the month.) The interest rate paid on bonds is 5% per month. It costs $10 every time Mary sells a bond. (a) Describe briefly how Mary should go about deciding how much money to hold. (b) Mary can switch from bonds to cash up to a maximum of three times. How many times should Mary switch from bonds to cash? (c) What is Mary's optimal balance?

Explain all of the determinants of money demand. Also include a brief explanation of how a change in each of these determinants would cause a reduction in money demand.

Explain why the theory of money demanded presented in the book may be more complicated in real life.

What is meant by the term structure of interest rates?

Answer the following three questions dealing with monetary policy. (a) Explain how the Federal Reserve might carry out a "tight" monetary policy. (b) Explain how the Federal Reserve might carry out an "easy" monetary policy. (c) How would each of the policies affect the equilibrium interest rate?

Graphically demonstrate how an increase in the level of aggregate output can have an impact on the money market and ultimately on the equilibrium interest rate.