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Current time:0:00Total duration:7:34

Money supply and demand impacting interest rates

Video transcript

now that we know that we can view interest rates as essentially the price of renting money I want to go through a bunch of scenarios just so we can understand how different things that happen in the economy might affect interest rates so I'll just draw a bunch of supply and demand curves right over here and once again we're talking about the market for essentially renting money so that right over here is the price of money which we know is the interest rate the interest rate on the vertical axis and then in the horizontal axis we have the quantity of money that is borrowed or lent in a given time period so quantity and this is in a given time period that is borrowed or lent so borrowed quantity borrowed let's just say in a quantity borrowed in a year and we know that there's some if we just want to draw a demand curve our starting demand curve the first few dollars out in the economy people are willing to pay a very high interest rate on them and then every incremental dollar after that people will get less marginal benefit they might not find as good of a place to put that money they're borrowing it for a reason they're either going to borrow it to consume to buy something that they always wanted that they think will make them happy or more likely they're borrowing it to invest it and hopefully getting a return higher than what they are borrowing at and so you have a marginal benefit curve that look would be downward sloping something like that maybe it might look something like if it looks something like that so that is our demand curve or our marginal benefit curve and the supply curve and once again this is the exact same logic we use with the demand supply curve for any good or service for money might look like this those first few dollars someone has a very low opportunity cost of lending it out so they're willing to lend it out at a very low interest rate and then every incremental dollar after that there's higher opportunity costs and so people will lend it out at a higher and higher rate and then you have a mark a market equilibrium interest rate and so let me copy and paste this and then we could think about what happens in different scenarios so copy and paste so now we have two scenarios that we can work on and then let me just do one more three scenarios now let's think of a couple let's say that the central Bank of our country and in the United States that would be the Federal Reserve the central bank prints more money and then decides to lend out that money and that actually is in the previous video I talked about the central bank printing money and then dropping it from helicopters that is not how money is actually distributed it is distributed when when central bank's print money the way that it enters into circulation in most countries is that the central bank then goes and essentially lends that money the way it's done in the US Fed for the most part they go out and buy government securities which is essentially lending money to the federal government and they do that because that's considered to be the safest investment but they go out there and they lend money and so if some is more money so if this is our original supply curve if this is our original supply curve but now your federal your central bank is printing more money and lending it out what is going to happen over here well your supply curve is going to shift to the right at any given at any given price at any given interest rate you're going to have a larger quantity of money being available so it might look something like it might your new supply curve might look something like that and 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 and that's why when the when the Federal Reserve says I want to lower interest rates they do so by printing money and and they print that money and they lend it out in the market and that essentially has the effect of lowering interest rates now let's think about another situation let's say so this is this is the Fed Fed prints prints and lens and lens money lends money and they're lending the money by buying government bonds when you buy a government bond you're essentially lending that money to the federal government and I've done other videos on that where we go into a little bit more detail on that now let's think of another situation let's think about consumer consumer savings consumer savings go down so one interesting thing about savings savings and investment are two opposite sides of the same named coin so when you save money so money you literally put it into a bank so that you have the whole financial system right over here so this is the financial system financial system that money is then goes out and it lit is lent to other people and that for the most part hopefully that money when it's lent is used to invest in some way so this is lending so if consumer savings goes down that means that the supply of money will be shifted to the left and any given price or any given interest rate there will be less money available so in this situation our supply curve is shifting to is shifting to the left and just that would increase interest rates and then you could even make an argument that if consumer savings is going down consumers are borrowing or going to borrow less as well and you could argue that maybe demand would go up as well and so your your demand could go up and that would make that would make in the equilibrium interest rate even even higher now let's do another scenario let's say that the federal government in an effort to let's say that they they for whatever reason they're trying to finance a war or some type of public works project and they don't want to raise taxes so the government decides to borrow a lot more money so the government the government the government is essentially going to go into a deeper is going to expand its deficit it's going to government is going to borrow borrow money so here our supply isn't changing I'm assuming that the central bank isn't changing its policies how much it's printing and savings rates aren't changing but the demand is going to go up the government is borrowing money so the government or it's going to borrow more money than it was already doing so at any given price the demand for money is going to increase we're going to shift to the right and our new equilibrium interest rate the remember the rental price of money is going is going to go up so the whole point of this is just to show you that you really can think about money like any other good or service if the supply of money goes up then the prep then the price of money which is interest rates will go down let me write the down so if the supply if the supply goes up then the price which is just interest rates interest rates goes down if the demand goes up then the price if the demand remember that if the demand goes up then the price of money will go up so interest rates interest rates will go interest rates will go up and then we can think about all of the other combinations where one demand goes down then interest rates would go down which is essentially just price the supply went down interest rates would go up if something becomes more scarce the price of it goes up so the whole point of this is just show that it's not that complicated you'll see people say oh you know government borrowing it's crowding out other savings interest rates go up and it sounds like something deep is happening but it really they're just talking about the supply and demand for money and you just have to remember that interest rates really are nothing more than the rental price for money