The Money Market
| English | Chinese | Pinyin |
|---|---|---|
| money market | 货币市场 | huò bì shì chǎng |
| central bank | 中央银行 | zhōng yāng yín háng |
| money supply | 货币供给 | huò bì gōng jǐ |
| demand for money | 货币需求 | huò bì xū qiú |
| equilibrium nominal interest rate | 均衡名义利率 | jūn héng míng yì lì lǜ |
What sets the interest rate
- Just like any market, money has a demand side and a supply side.
- Bring them together and you get the nominal interest rate.
- This is the money market 货币市场.
- It is the lever the central bank pulls to steer the economy.
Money demand slopes down
- The demand for money 货币需求 slopes downward against the interest rate.
- The interest rate is the opportunity cost of holding cash (cash earns no interest).
- So when rates are high, people hold less money and buy bonds instead.
Which way does the interest rate move?
A higher money supply lowers the equilibrium interest rate; higher money demand raises it. Money demand slopes down; money supply is vertical.
The demand for money slopes downward against the interest rate because:
When rates are high, holding cash costs more, so people hold less and buy bonds.
When interest rates are high, people tend to:
High rates make holding non-interest cash costly, so people move into bonds.
Money supply is vertical
- The money supply 货币供给 is set by the central bank 中央银行, so it is a vertical line — it does not depend on the interest rate.
- Where demand and supply cross is the equilibrium nominal interest rate 均衡名义利率.
The money supply curve is drawn as:
The central bank fixes the quantity of money, so it does not depend on the interest rate.
Where money demand crosses money supply is the equilibrium ______ interest rate.
The money market sets the nominal interest rate.
Shifting the market
- If the central bank raises the money supply (the vertical line slides right), the equilibrium interest rate falls.
- Worked idea. More money than people want to hold → they buy bonds → bond prices rise, yields fall → the interest rate settles lower.
- If money demand rises (say output grows and people need more cash), the interest rate rises.
- That fall in the interest rate is the first step of expansionary monetary policy.
If the central bank raises the money supply, the equilibrium interest rate:
More money than people want to hold → they buy bonds → yields fall → the rate settles lower.
If real output grows and people need more cash to shop, money demand rises and the interest rate rises.
A rightward shift in money demand pushes the equilibrium interest rate up.
The money market sets the nominal interest rate where money demand (downward) meets money supply (a vertical line fixed by the central bank). Raising the money supply lowers the equilibrium interest rate; a rise in money demand raises it.