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Current time:0:00Total duration:3:59

Equilibrium nominal interest rates in the money market

AP.MACRO:
MKT‑3 (EU)
,
MKT‑3.A (LO)
,
MKT‑3.A.2 (EK)
,
MKT‑3.B (LO)
,
MKT‑3.B.1 (EK)
,
MKT‑3.C (LO)
,
MKT‑3.C.1 (EK)
,
MKT‑3.D (LO)
,
MKT‑3.D.1 (EK)

Video transcript

so we've spent a lot of time justifying why we have this downward sloping demand curve for money but you're probably asking well this is a market what we need to think about an equilibrium point and to do that we need to think about the supply of money and in previous videos we've started thinking about the supply of money and we'll think more in future videos about different monetary policies but in a classical model we assume a perfectly inelastic supply of money so we draw it as a vertical line which is another way of saying that the supply of money is not impacted by the nominal interest rate so this is the supply of money I'll call that money supply one where it intersects the quantity of money I'll just call that M sub one right over here and so this point where it intersects is the equilibrium point in our money market the equilibrium nominal interest rate right over here we could call our 1 this would be the opportunity cost for holding money now I have to give a little bit of a disclaimer this is a classical model here we'll talk more about it in future videos and most introductory economics class talked about this classical model where the central bank might set the supply of money and that doesn't change according to the nominal interest rate and then the nominal interest rate gets set essentially by this equilibrium point now in the world that we live in it actually goes the other way around central bank's actually target a nominal interest rate and if the central bank is able to achieve that target interest rate well that's going to impact the actual quantity of money so keep that little disclaimer in the back of your mind but in an introductory economics class we assume this world so now that we have this neat little model for our money market let's think about what would happen in different situations let's think about a situation where for whatever reason people lose confidence in the electrical grid what would happen to the demand curve for money and let's call this the MD sub 1 pause this video and think about it well if people lose trust in the electrical grid then this precautionary motive for holding money becomes stronger regardless of what the opportunity cost is of holding money people would want to hold more of it because like hey you know I don't know if I'll be able to access money if the lights go out again I'm not gonna be able to go to ATM or the banks are gonna close and so at any nominal interest rate I would or and in aggregate people and are going to want to hold more money and so that would shift the demand curve for money to the right I could have drawn it a little less hairy but there you go that would be M D sub two we have this shift to the right and then if that happened if you had this demand for money increase well then what happens to the actual equilibrium nominal interest rate if you look at this point right over here assuming that the quantity of money has not changed you have a new equilibrium interest rate nominal interest rate it has gone up and that makes sense if more people want to hold money in order for in order to get people to part with that money you have to offer them more the opportunity cost of holding that money has to go up and you could imagine the reverse scenario if for some reason people thought it's a lot less likely that the lights are gonna go out or they said you know I don't need as much cash around for transactions or I'm not really into speculation well then the demand curve for money would shift to the left and in that situation you would have a decrease in the equilibrium nominal interest rate I will leave you there always keep these models with a grain of salt there are simplifications of the real world especially here where we're assuming a perfectly inelastic supply of money which actually isn't the case in the real world but we can go with this for just for this purposes of starting to study the money market
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