ECON2123 Financial Markets
7
FINANCIAL MARKETS ECON 2123: Macroeconomics Prof. Fei DING The Hong Kong University of Science and Technology Ch3: The Goods Market LEARNING OBJECTIVES Understand sources and determinants of demand from decomposition of GDP. Define and derive the short run equilibrium output using two approaches. Describe effects of fiscal policy on equilibrium output, and its limitations. PREVIOUSLY … 2 WHAT’S SPECIAL ABOUT SEP. 17, 2015? The Federal Open Market Committee (FOMC) will announce its interest rate decision at 2pm US Eastern Time on Thursday, Sep. 17, 2015. 3 QUOTE OF THE DAY 4 Janet Yellen, Fed chair "Delaying action to tighten monetary policy until employment and inflation are already back to our objectives would risk overheating the economy. For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term." Source: The Outlook for the Economy, May 22, 2015 THIS JUST CAME IN 5 BREAKING NEWS Federal Reserve holds off on raising interest rates after market turmoil Thursday, September 17, 2015 2:03 PM EDT The Federal Reserve punted on Thursday, announcing it would keep interest rates near zero as officials assess the impact of tighter financial conditions and slower global growth on the domestic economy. The Fed’s decision, widely expected by investors, showed officials still lack confidence in the strength of the domestic economy even as the central bank has entered its eighth year of overwhelming efforts to stimulate growth. “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Fed said in a statement following a two-day meeting of its policy-making committee, the Federal Open Market Committee. Read more » WHAT’S SPECIAL ABOUT SEP. 17, 2015? The Federal Open Market Committee (FOMC) will announce its interest rate decision at 2pm US Eastern Time on Thursday, Sep. 17, 2015. Why do we care? ¾ US rate rise applying pressure to credit quality at Hong Kong banks ¾ Hong Kong homebuyers cancel deals amid fears of price slump sparked by US interest rate rise - and one even forfeits HK$2.55m deposit 6
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HKUST Fei Ding Macroeconomics
Transcript of ECON2123 Financial Markets
FIN
ANCI
AL M
ARKE
TSE
CO
N 2
12
3:
Ma
cro
eco
no
mic
s
Prof
. Fei
DIN
G
The
Hon
g Ko
ng U
nive
rsity
of S
cien
ce a
nd T
echn
olog
y
Ch3
: The
Goo
ds M
arke
t
LE
AR
NIN
G O
BJE
CTIV
ES
�U
nd
ers
tan
d s
ou
rce
s a
nd
de
term
ina
nts
of
de
ma
nd
fro
m d
eco
mp
osit
ion
of
GD
P.
�D
efi
ne
an
d d
eri
ve t
he
sh
ort
ru
n e
qu
ilib
riu
m o
utp
ut
usin
g t
wo
ap
pro
ach
es.
�D
escri
be
eff
ects
of
fisca
l p
olicy
on
eq
uilib
riu
m o
utp
ut,
an
d its
lim
ita
tio
ns.
PREV
IOUS
LY …
2
WH
AT’S
SPE
CIAL
ABO
UT S
EP. 1
7, 2
015?
Th
e F
ed
era
l O
pe
n M
ark
et
Co
mm
itte
e (
FO
MC
) w
ill
an
no
un
ce
its
in
tere
st
rate
de
cis
ion
at
2p
m U
S
Ea
ste
rn T
ime
on
Th
urs
da
y, S
ep
. 1
7, 2
01
5.
3
QUO
TE O
F TH
E D
AY
4
Jane
t Yel
len,
Fed
cha
ir
"Del
ayin
gac
tion
totig
hten
mon
etar
ypo
licy
until
empl
oym
ent
and
infla
tion
are
alre
ady
back
toou
robj
ectiv
esw
ould
risk
over
heat
ing
the
econ
omy.
Fort
his
reas
on,i
fthe
econ
omy
cont
inue
sto
impr
ove
asI
expe
ct,I
thin
kit
will
beap
prop
riat
eat
som
epo
int
this
year
tota
keth
ein
itial
step
tora
ise
the
fede
ral
fund
sra
teta
rget
and
begi
nth
epr
oces
sof
norm
aliz
ing
mon
etar
ypo
licy.
Tosu
ppor
ttak
ing
this
step
,how
ever
,Iw
illne
edto
see
cont
inue
dim
prov
emen
tin
labo
rm
arke
tco
nditi
ons,
and
Iw
illne
edto
bere
ason
ably
conf
iden
tth
atin
flatio
nw
illm
ove
back
to2
perc
ento
vert
hem
ediu
mte
rm."
Sour
ce: T
he O
utlo
ok fo
r the
Eco
nom
y, M
ay 2
2, 2
015
THIS
JUST
CAM
E IN
5
BR
EA
KIN
G N
EW
S
Fe
de
ral R
ese
rve
ho
lds o
ff o
n r
ais
ing in
tere
st
rate
s a
fte
r m
ark
et
turm
oil
Th
urs
da
y, S
ep
tem
be
r 1
7, 2
01
5 2
:03
PM
ED
T
Th
e F
ed
era
l R
ese
rve
pu
nte
d o
n T
hu
rsd
ay,
an
no
un
cin
g it
wo
uld
ke
ep
in
tere
st
rate
s n
ea
r ze
ro a
s
off
icia
ls a
sse
ss t
he
im
pa
ct
of
tigh
ter
fin
an
cia
l co
nd
itio
ns a
nd
slo
we
r glo
ba
l gro
wth
on
th
e d
om
esti
c
eco
no
my.
Th
e F
ed
’s d
ecis
ion
, w
ide
ly e
xpe
cte
d b
y in
vesto
rs, sh
ow
ed
off
icia
ls s
till la
ck
co
nfi
de
nce
in
th
e
str
en
gth
of
the
do
me
sti
c e
co
no
my
eve
n a
s t
he
ce
ntr
al b
an
k h
as e
nte
red
its
eig
hth
ye
ar
of
ove
rwh
elm
ing e
ffo
rts t
o s
tim
ula
te g
row
th.
“Re
ce
nt
glo
ba
l e
co
no
mic
an
d f
ina
ncia
l d
eve
lop
me
nts
ma
y re
str
ain
eco
no
mic
acti
vit
y so
me
wh
at
an
d
are
lik
ely
to
pu
t fu
rth
er
do
wn
wa
rd p
ressu
re o
n in
fla
tio
n in
th
e n
ea
r te
rm,”
th
e F
ed
sa
id in
a
sta
tem
en
t fo
llo
win
g a
tw
o-d
ay
me
eti
ng o
f it
s p
olicy-
ma
kin
g c
om
mit
tee
, th
e F
ed
era
l O
pe
n M
ark
et
Co
mm
itte
e.
Re
ad
mo
re »
WH
AT’S
SPE
CIAL
ABO
UT S
EP. 1
7, 2
015?
�Th
e F
ed
era
l O
pe
n M
ark
et
Co
mm
itte
e (
FO
MC
)
will a
nn
ou
nce
its
in
tere
st
rate
de
cis
ion
at
2p
m
US
Ea
ste
rn T
ime
on
Th
urs
da
y, S
ep
. 1
7,
20
15
.
�W
hy
do
we
ca
re?
¾U
S r
ate
ris
e a
pp
lyin
g p
ressu
re t
o c
red
it q
ua
lity
at
Ho
ng K
on
g b
an
ks
¾H
on
g K
on
g h
om
eb
uye
rs c
an
ce
l d
ea
ls a
mid
fe
ars
of
pri
ce
slu
mp
sp
ark
ed
by
US
in
tere
st
rate
ris
e -
an
d
on
e e
ven
fo
rfe
its H
K$
2.5
5m
de
po
sit
6
QE
1, Q
E2,
and
QE
3Th
e ex
pres
sion
"Q
E2"
beca
me
a "u
biqu
itous
nic
knam
e" in
201
0, u
sual
ly u
sed
to
refe
r to
a se
cond
roun
d of
qua
ntita
tive
easi
ngby
cen
tral b
anks
in th
e U
nite
d St
ates
. Ret
rosp
ectiv
ely,
the
roun
d of
qua
ntita
tive
easi
ng p
rece
ding
QE2
may
be
calle
d "Q
E1".
Sim
ilarly
, "Q
E3"
refe
rs to
the
third
roun
d of
qua
ntita
tive
easi
ngfo
llow
ing
QE2
.
QE3
was
ann
ounc
ed o
n Se
ptem
ber 1
3, 2
012.
In a
n 11
-to-1
vot
e, th
e Fe
dera
l R
eser
ve d
ecid
ed to
laun
ch a
new
$40
bill
ion
a m
onth
, ope
n-en
ded,
bon
d pu
rcha
sing
prog
ram
; to
cont
inue
unt
il at
leas
t mid
-201
5.A
ccor
ding
to
NA
SDA
Q.c
om, t
his
is e
ffec
tivel
y a
stim
ulus
prog
ram
whi
ch a
llow
s th
e Fe
dera
l R
eser
ve to
prin
t $40
bill
ion
dolla
rs a
mon
thfo
r an
unlim
ited
amou
nt o
f tim
e.R
atin
gs fi
rm E
gan-
Jone
s sa
id it
bel
ieve
s th
e Fe
d’s
deci
sion
“w
ill h
urt t
he
U.S
. eco
nom
y an
d, b
y ex
tens
ion,
cre
dit q
ualit
y.”
As
a re
sult
the
firm
onc
e ag
ain
slas
hed
the
U.S
. bon
d ra
ting
brin
ging
it d
own
to A
A-.
Fede
ral R
eser
ve c
hairm
an
Ben
Ber
nank
e ac
know
ledg
ed c
once
rns
abou
t inf
latio
n.
QUA
NTI
TATI
VE E
ASIN
G (Q
E)
7
THIN
GS
TO T
HIN
K AB
OUT
…
�W
hy
are
QE
s u
se
d t
o f
igh
t re
ce
ssio
n?
Ho
w d
o t
he
y
wo
rk?
�W
hy
are
pe
op
le t
alk
ing a
bo
ut
rais
ing t
he
ra
te n
ow
?
�W
ha
t’s t
he
re
lati
on
be
twe
en
in
tere
st
rate
an
d o
vera
ll
co
nd
itio
n o
f th
e e
co
no
my?
�W
ha
t w
ill b
e t
he
im
pa
cts
if
the
Fe
d d
ecid
es t
o
incre
ase
th
e in
tere
st
rate
, o
n U
S e
co
no
my
an
d o
n H
K
eco
no
my?
8
Ch4
: Fin
anci
al M
arke
ts
LE
AR
NIN
G O
BJE
CTIV
ES
�E
xpla
in f
acto
rs t
ha
t d
ete
rmin
e t
he
de
ma
nd
fo
r m
on
ey
an
d w
rite
do
wn
th
e
mo
ne
y d
em
an
d f
un
cti
on
.
�D
efi
ne
an
d d
eri
ve e
qu
ilib
riu
m in
tere
st
rate
in t
he
fin
an
cia
l m
ark
ets
.
�D
escri
be
ro
les o
f b
an
ks a
nd
un
de
rsta
nd
ho
w t
he
su
pp
ly a
nd
de
ma
nd
of
mo
ne
y ch
an
ge
wit
h a
nd
wit
ho
ut
the
pre
se
nce
of
ba
nk
s.
9
FIN
ANCI
AL M
ARKE
TS O
VER
VIEW
�F
ina
ncia
l m
ark
ets
tra
de
fin
an
cia
l a
sse
ts.
¾W
ha
t a
sse
ts?
Sto
ck
s, b
on
ds, in
dic
es, fu
ture
s, e
tc.,
an
d m
on
ey
(ca
sh
an
d c
he
ck
s).
¾W
hy
tra
de
?H
op
e f
or
retu
rn(i
nte
rests
& c
ap
ita
l
ga
ins).
�M
on
ey
is s
pe
cia
l b
eca
use
¾U
se
fo
r tr
an
sa
cti
on
s –
ca
nn
ot
pa
y fo
r lu
nch
wit
h
sto
ck
s a
nd
bo
nd
s!
¾N
o (
or
clo
se
to
ze
ro)
retu
rn.
10
MO
NEY
~Zer
o in
tere
sts
Easy
tran
sact
ions
A ty
pe o
f wea
lth
With
out M
oney
Self-
suffi
cien
cy
Bart
er e
cono
my 11
�M
on
ey
is t
he
me
diu
m o
f
exc
ha
nge
, b
ut
ha
s z
ero
re
turn
.
�O
the
r a
sse
ts h
ave
hig
he
r re
turn
s,
bu
t ca
nn
ot
be
use
d t
o p
ay
bills
.
¾C
ostl
yto
co
nve
rt in
to m
on
ey
(tra
nsa
cti
on
co
sts
).
The
ease
with
whi
ch m
oney
is c
onve
rted
into
oth
er th
ings
–go
ods a
nd se
rvic
es –
is so
met
imes
cal
led
mon
ey’s liquidity.
Mon
ey is
the
mos
t liq
uid
asse
t of a
ll.
MO
NEY
VS.
OTH
ER F
INAN
CIAL
ASS
ETS
12
MO
NEY
–TH
E M
OST
LIQ
UID
OF
ALL
�Th
ere
are
tw
o t
ype
s o
f m
on
ey.
¾C
ash
/cu
rre
ncy:
co
ins a
nd
bills
¾C
he
cka
ble
de
po
sit
s: ch
eck
ing a
cco
un
ts a
t b
an
ks
an
d f
ina
ncia
l in
sti
tuti
on
s
�M
on
ey
or
liq
uid
ity
ava
ila
ble
in
th
e m
ark
et
is
me
asu
red
by
¾M
1 =
ca
sh
+ c
he
cka
ble
de
po
sit
s
¾Th
ere
are
M2
(ne
ar
mo
ne
y), M
3 (
ne
ar,
ne
ar
mo
ne
y),
etc
.
13
THE
DEM
AND
FO
R M
ON
EY
�M
on
ey
vs. B
on
d (
a s
imp
lifi
ca
tio
n)
¾G
rou
p a
ll o
the
r fi
na
ncia
l a
sse
ts t
oge
the
r Æ
bo
nd
s:p
osit
ive
inte
rest
rate
i >
0, b
ut
ca
nn
ot
be
use
d f
or
tra
nsa
cti
on
s.
¾H
ow
to
div
ide
yo
ur
we
alt
h b
etw
ee
n m
on
ey
an
d b
on
ds?
�Tr
ad
e-o
ff r
etu
rn a
nd
liq
uid
ity!
¾H
igh
er
leve
l o
f tr
an
sa
cti
on
s Æ
mo
re m
on
ey
¾H
igh
er
inte
rest
rate
on
bo
nd
s Æ
mo
re b
on
ds
14
�In
cre
ase
s p
rop
ort
ion
ally
wit
h n
om
ina
l in
co
me
($Y)
–ca
ptu
res
tra
nsa
cti
on
pu
rpo
se
of
mo
ne
y
¾S
up
po
se
re
al in
co
me
is u
nch
an
ge
d b
ut
pri
ce
s d
ou
ble
le
ad
ing t
o a
do
ub
lin
g o
f n
om
ina
l in
co
me
. W
e n
ee
d t
o h
old
tw
ice
as m
uch
ca
sh
to
bu
y th
e s
am
e c
on
su
mp
tio
n b
aske
ts.
¾H
ype
rin
fla
tio
n –
su
pe
r h
igh
in
fla
tio
n u
nd
er
wh
ich
pe
op
le m
ust
ca
rry
lots
of
mo
ne
y, b
ut
rea
l in
co
me
is u
nch
an
ge
d.
�D
ecre
ase
s w
ith
th
e in
tere
st
rate
, d
escri
be
d b
y th
e f
un
cti
on
L(i)
–ca
ptu
res t
he
op
po
rtu
nit
y co
st
of
mo
ne
y.
¾H
old
le
ss m
on
ey
an
d p
ut
mo
re in
to b
on
ds a
s i
incre
ase
s.
$(
)d
MY
Li
��
�
THE
DEM
AND
FO
R M
ON
EY
15
Hyp
erin
flatio
nis
def
ined
as i
nfla
tion
that
exc
eeds
50
perc
ent
per m
onth
, whi
ch is
just
ove
r 1%
a d
ay.
Even
tual
ly, w
hen
cost
s bec
ome
too
grea
t with
hyp
erin
flatio
n,
the
mon
ey lo
ses i
ts ro
le a
s sto
re o
f val
ue, u
nit o
f acc
ount
and
m
ediu
m o
f exc
hang
e. B
arte
ring
or u
sing
com
mod
ity m
oney
be
com
es p
reva
lent
.
16 17
MYL
id
$(
)(
)�
Fora
give
nle
velo
fnom
inal
inco
me,
alo
weri
nter
estr
ate
incr
ease
sth
ede
man
dfo
rm
oney
.At
agi
ven
inte
rest
rate
,an
incr
ease
inno
min
alin
com
esh
ifts
the
dem
and
form
oney
toth
erig
ht.
The
Dem
and
for M
oney
Fig
ure
4 -1
THE
DEM
AND
FO
R M
ON
EY –
GR
APH
18
MO
NEY
MAR
KET
EQUI
LIBR
IUM
�M
on
ey
de
ma
nd
(M
d ) =
Mo
ne
y su
pp
ly (
Ms )
�W
ho
su
pp
lie
s m
on
ey?
¾C
urr
en
cy/
ca
sh
: ce
ntr
al b
an
ks
�H
K Æ
Ho
ng K
on
g M
on
eta
ry A
uth
ori
ty(H
KM
A)
(lim
ite
d
role
)
�U
S Æ
Fe
de
ral R
ese
rve
Ba
nk
s (
the
Fe
d)
�E
uro
Zo
ne
ÆE
uro
pe
an
Ce
ntr
al B
an
k (
EC
B)
�C
hin
a Æ
Pe
op
le’s
ba
nk
of
Ch
ina
(P
BC
)
¾C
he
cka
ble
de
po
sit
s: co
mm
erc
ial b
an
ks
�A
ssu
me
mo
ne
y su
pp
ly M
s=
cu
rre
ncy
(fo
r n
ow
).19
�Le
t th
e c
en
tra
l b
an
k’s
su
pp
ly o
f m
on
ey
= M
.
¾A
ssu
me
co
nsta
nt
su
pp
ly, in
de
pe
nd
en
t o
f in
tere
st
rate
, o
r
pri
ce
, o
r in
co
me
.
�Th
e e
qu
ilib
riu
m in
fin
an
cia
l m
ark
ets
be
co
me
s
�Th
is e
qu
ilib
riu
m is c
alle
d t
he
LM
rela
tio
n.
¾L Æ
liq
uid
ity
–h
ow
ea
sily
an
asse
t ca
n b
e e
xch
an
ge
d f
or
mo
ne
y.
¾M
Æm
on
ey
–th
e m
ost
liq
uid
of
all a
sse
ts
¾LM
re
lati
on
Æd
em
an
d f
or
liq
uid
ity
= s
up
ply
of
mo
ne
y
$(
)M
YL
i
MO
NEY
MAR
KET
EQUI
LIBR
IUM
20
The
inte
rest
rate
mus
t be
such
that
the
supp
ly of
m
oney
(whi
ch is
in
depe
nden
tof t
he in
tere
st
rate
) is
equa
l to
the
dem
and
for m
oney
(whi
ch
does
depe
nd o
n th
e in
tere
st ra
te).
The
Det
erm
inat
ion
of
the
Inte
rest
Rat
e
Fig
ure
4 -2
$(
)M
YL
i
MO
NEY
MAR
KET
EQUI
LIBR
IUM
21
An in
crea
se in
nom
inal
inco
me
lead
s to
an
incr
ease
in th
e in
tere
st ra
te.
$Y ↑
→ tr
ansa
ctio
n ↑ →
Md↑
(at a
ny i)
→ m
oney
dem
and
curv
e shi
fts to
the r
ight
.
The
Effe
cts o
f an
Incr
ease
in
Nom
inal
Inco
me
on th
e In
tere
st R
ate
Fig
ure
4 -3
$(
)M
YL
i
MO
NEY
MAR
KET
EQUI
LIBR
IUM
22
An in
crea
se in
the
supp
ly of
mon
ey le
ads
to a
dec
reas
e in
the
in
tere
st ra
te.
The
Effe
cts o
f an
Incr
ease
in
the
Mon
ey S
uppl
y on
the
Inte
rest
Rat
e
Fig
ure
4 -4
$(
)M
YL
i
Ms'
MO
NEY
MAR
KET
EQUI
LIBR
IUM
23
REF
RES
H
Th
e m
on
ey
de
ma
nd
cu
rve
will sh
ift
to t
he
rig
ht
wh
en
wh
ich
of
the
fo
llo
win
g o
ccu
rs?
1)
a r
ed
ucti
on
in
th
e in
tere
st
rate
2)
an
in
cre
ase
in
th
e m
on
ey
su
pp
ly
3)
an
in
cre
ase
in
in
co
me
4)
all o
f th
e a
bo
ve
5)
no
ne
of
the
ab
ove
24
MO
NET
ARY
POLI
CY
�M
sis
a s
tra
igh
t lin
e, w
ha
t d
oe
s it
me
an
?
¾G
ive
n, co
nsta
nt,
exo
ge
no
us
¾Th
e c
en
tra
l b
an
k c
ho
ose
s M
sa
s a
po
licy
too
l to
ach
ieve
a
targ
et
inte
rest
rate
i.
¾In
pra
cti
ce
, fi
rst
ch
oo
se
iÆ
Ms
to a
ch
ieve
th
at
i.
�O
pe
n m
ark
et
op
era
tio
ns (
OM
O):
bu
yin
g o
r se
llin
g
bo
nd
s b
y th
e c
en
tra
l b
an
k t
o c
ha
nge
Ms .
¾B
uyi
ng b
on
ds: in
cre
ase
MsÆ
exp
an
sio
na
ry p
olicy
¾S
ellin
g b
on
ds: d
ecre
ase
MsÆ
co
ntr
acti
on
ary
po
licy
25
Supp
ose
nom
inal
in
com
e in
crea
ses
and
that
the
cent
ral b
ank
want
s to
kee
p th
e in
tere
st ra
te u
ncha
nged
. W
hat m
onet
ary
polic
y sh
ould
it u
se?
MO
NET
ARY
POLI
CY
26
Open
mar
ket o
pera
tions
lea
d to
equa
l cha
nges
in
asse
ts an
d lia
bilit
ies.
The a
sset
s of t
he ce
ntra
l ba
nk ar
e the
bon
ds it
hol
ds.
The l
iabilit
ies ar
e the
stoc
k of
mon
ey in
the e
cono
my.
An
open
mar
ket o
pera
tion
in w
hich
th
e ce
ntra
l ban
k bu
ys b
onds
an
d iss
ues
mon
ey in
crea
ses
both
ass
ets
and
liabi
lities
by
the
sam
e am
ount
.
The
Bal
ance
She
et o
f th
e C
entr
al B
ank
and
the
Effe
cts o
f an
Exp
ansi
onar
y O
pen
Mar
ket O
pera
tion
Fig
ure
4 -5
OPE
N M
ARKE
T O
PER
ATIO
NS
27
�B
on
d issu
er
is a
bo
rro
we
r, p
rom
ise
s a
ce
rta
in p
aym
en
t
at
a c
ert
ain
tim
e (
ma
turi
ty d
ate
).
�C
urr
en
t p
rice
dir
ectl
y d
ete
rmin
es t
he
re
turn
on
th
e
bo
nd
.
�E
xam
ple
of
a 1
-ye
ar
T-b
ill is
su
ed
by
US
go
vern
me
nt,
wit
h a
pro
mis
ed
pa
yme
nt
of
$1
00
:
�H
igh
er
pri
ce
lo
we
rs t
he
re
turn
i, a
nd
vic
e v
ers
a.
iP
PB
B
�$1
00$
$�
$$1
00P
iB
�1
BON
D P
RIC
E AN
D Y
IELD
28
OPE
N M
ARKE
T O
PER
ATIO
NS
OM
O is a
sim
ple
de
ma
nd
-su
pp
ly r
ea
cti
on
.
�E
xpa
nsio
na
ry
¾C
en
tra
l b
an
k b
uys
bo
nd
s Æ
bo
nd
pri
ce
↑ Æ
inte
rest
rate
↓
¾B
ala
nce
sh
ee
t sh
ow
s ↑
asse
ts &
lia
bilit
ies Æ
incre
ase
mo
ne
y su
pp
ly.
�C
on
tra
cti
on
ary
¾C
en
tra
l b
an
k s
ells b
on
ds Æ
bo
nd
pri
ce
↓ Æ
inte
rest
rate
↑
¾B
ala
nce
sh
ee
t sh
ow
s ↓
asse
ts &
lia
bilit
ies Æ
de
cre
ase
mo
ne
y su
pp
ly.
Op
tio
na
l R
ea
din
g:H
on
g K
on
g v
ers
ion
of
OM
O
29
MO
NET
ARY
POLI
CY –
SUM
MAR
Y
�G
ove
rnm
en
t’s f
isca
l p
olicy
infl
ue
nce
s t
he
go
od
s
ma
rke
t; c
en
tra
l b
an
k’s
mo
ne
tary
po
licy
infl
ue
nce
s t
he
fin
an
cia
lm
ark
et.
�C
en
tra
l b
an
k c
ho
ose
s i
by
ad
justi
ng M
s .
�In
cre
asin
g m
on
ey
su
pp
ly t
oo
mu
ch
ma
y le
ad
to
infl
ati
on
in
th
e m
ed
ium
an
d lo
ng r
un
.
�P
reve
nti
ng “
su
pe
r-in
fla
tio
n”
is t
he
go
al fo
r m
an
y
ce
ntr
al b
an
ks a
s w
ell.
¾W
ha
t sh
ou
ld t
he
Fe
d d
o a
bo
ut
the
eff
ects
of
QE
s?
30
INTE
RES
T R
ATE
–CA
VEAT
S
�W
e a
ssu
me
d o
ne
in
tere
st
rate
i, b
ut
in r
ea
l w
orl
d,
ma
ny
rate
s.
¾Tr
ea
su
ry b
ills
(T-b
ills
) m
atu
re in
1 y
ea
r o
r le
ss.
¾Tr
ea
su
ry n
ote
s (
T-n
ote
s)
ma
ture
in
2-1
0 y
ea
rs.
¾Tr
ea
su
ry b
on
ds (
T-b
on
ds)
ma
ture
20
-30
ye
ars
.
¾Tim
e d
ep
osit
s, m
on
ey
ma
rke
t sa
vin
gs a
cco
un
t, e
tc.
�Th
e c
en
tra
l b
an
k c
an
, th
rou
gh
op
en
ma
rke
t
op
era
tio
ns, ch
an
ge
th
e s
ho
rt-t
erm
inte
rest
rate
.
31
THE
MO
NEY
MAR
KET
–SU
MM
ARY
�In
tere
st
rate
i¾
Pri
ce
or
co
nve
rsio
n r
ati
oo
f cu
rre
nt
vs. fu
ture
co
nsu
mp
tio
ns
¾D
ete
rmin
ed
by
de
ma
nd
an
d s
up
ply
of
mo
ne
y
�S
o f
ar,
on
ly f
ocu
s o
n c
urr
en
cy/
ca
sh
co
ntr
olle
d b
y th
e
ce
ntr
al b
an
k t
hro
ugh
OM
O.
�B
ut
M1
= c
urr
en
cy/
ca
sh
+ c
he
cka
ble
de
po
sit
s.
¾C
he
cka
ble
de
po
sit
s a
re s
up
plie
d b
y (p
riva
te)
ba
nk
s.
¾C
an
ce
ntr
al b
an
k s
till c
on
tro
l i?
32
WH
AT B
ANKS
DO
�F
ina
ncia
l in
term
ed
iari
es:re
ce
ive
(b
orr
ow
) fu
nd
s f
rom
so
me
an
d
pro
vid
e (
len
d)
to o
the
rs.
¾D
ep
osit
s:
lia
bilit
ies o
f b
an
ks
¾Lo
an
s,
bo
nd
s,
oth
er
asse
ts:
asse
ts o
f b
an
ks
�S
ub
ject
to r
egu
lati
on
sb
eca
use
of
the
ris
kin
volv
ed
.
¾C
red
it r
isk
:W
ha
t if
th
e lo
an
s c
an
no
t b
e r
ep
aid
?
¾Liq
uid
ity
risk
:W
ha
t if
th
e lo
an
s c
an
no
t b
e c
alle
d b
ack
wh
en
I n
ee
d t
he
mo
ne
y?
�R
ese
rve
ra
tio
:%
of
de
po
sit
s t
ha
t m
ust
be
ke
pt
as “
rese
rve
”
~1
0%
in
th
e U
S
¾Th
e r
est:
lo
an
s,
bo
nd
s,
inte
rba
nk
lo
an
s,
etc
.
33
Ban
k R
uns
Rum
ors t
hat a
ban
k is
not
doi
ng w
ell a
nd so
me
loan
s will
not
be
repa
id, w
ill le
ad p
eopl
e to
clo
se th
eir a
ccou
nts a
t tha
t ban
k.
If en
ough
peo
ple
do so
, the
ban
k w
ill ru
n ou
t of r
eser
ves—
a ba
nk ru
n.
To a
void
ban
k ru
ns, t
he U
.S. g
over
nmen
t pro
vide
s fed
eral
de
posi
t ins
uran
ce.
An a
ltern
ativ
e so
lutio
n is
nar
row
ban
king
, whi
ch w
ould
re
stric
t ban
ks to
hol
ding
liqu
id, s
afe,
gov
ernm
ent b
onds
, suc
h as
T-b
ills.
34
The
Bal
ance
She
et o
f Ban
ks
and
the
Bal
ance
She
et o
f th
e C
entr
al B
ank,
Rev
isite
d
Fig
ure
4 -6
WH
AT B
ANKS
DO
35
OM
O –
BALA
NCE
SH
EET
ANAL
YSIS
Ce
ntr
al b
an
k b
ou
gh
t $
10
,00
0 b
on
d f
rom
no
nb
an
k.
Ce
ntr
al b
an
kN
on
ba
nk
(th
e p
ub
lic)
Ce
ntr
al b
an
k b
ou
gh
t $
10
,00
0 b
on
d f
rom
a c
om
me
rcia
l b
an
k.
Ce
ntr
al b
an
kC
om
me
rcia
l b
an
k
asse
tslia
bilit
ies
bond
s+$
10,0
00cu
rren
cy(in
circ
ulat
ion)
+$10
,000
asse
tslia
bilit
ies
bond
s-$
10,0
00cu
rren
cy(o
rcas
h)+$
10,0
00
asse
tslia
bilit
ies
bond
s+$
10,0
00re
serv
es+$
10,0
00
asse
tslia
bilit
ies
bond
s-$
10,0
00re
serv
es+$
10,0
00
36
WH
AT B
ANKS
DO
–M
ON
EY M
ULTI
PLIE
R E
FFEC
T
�W
ith
ou
tb
an
ks, ce
ntr
al b
an
k m
on
ey
=m
on
ey
su
pp
ly.
�W
ith
ba
nk
s,
ce
ntr
al b
an
k m
on
ey
<m
on
ey
su
pp
ly,
be
ca
use
rese
rve
is o
nly
a f
racti
on
of
tota
l ch
ecka
ble
de
po
sit
s.
¾E
xam
ple
: $
10
0 c
en
tra
l b
an
k m
on
ey
ge
ts d
ep
osit
ed
, w
ith
10
% r
ese
rve
¾1
stro
un
d:
Ba
nk
A r
ece
ive
s $
10
0 d
ep
osit
, a
t m
ost
$9
0 c
an
be
le
nt
ou
t.
(ch
ecka
ble
de
po
sit
+$
10
0)
¾2
nd
rou
nd
: Th
e $
90
lo
an
ge
ts d
ep
osit
ed
in
ba
nk
B,
at
mo
st
$8
1 c
an
be
len
t o
ut.
(ch
ecka
ble
de
po
sit
+$
90
)
¾3
rdro
un
d:
Th
e $
81
lo
an
ge
ts d
ep
osit
ed
in
ba
nk
C,
at
mo
st
$7
2.9
ca
n b
e
len
t o
ut.
(ch
ecka
ble
de
po
sit
+$
81
) A
nd
so
on
, a
nd
so
on
…
¾M
1 =
10
0+
90
+8
1+
72
.9+
… =
10
0/0
.1=
10
00
�E
qu
ilib
riu
m: m
on
ey
de
ma
nd
= m
on
ey
su
pp
ly =
ce
ntr
al b
an
k
mo
ne
y ×
mo
ne
y m
ult
iplie
r
37
�D
em
an
d f
or
ce
ntr
al b
an
k m
on
ey
= c
urr
en
cy
+ r
ese
rve
s
�S
up
ply
of
ce
ntr
al b
an
k m
on
ey
is c
on
tro
lle
d b
y th
e c
en
tra
l
ba
nk
.
�Th
e e
qu
ilib
riu
m in
tere
st
rate
is s
uch
th
at
the
de
ma
nd
an
d
the
su
pp
ly o
f ce
ntr
al b
an
k m
on
ey
are
eq
ua
l.
CEN
TRAL
BAN
K M
ON
EY: D
EMAN
D A
ND
SUP
PLY
38
Fig
ure
4-7
D
ete
rmin
an
ts o
f th
e D
em
an
d a
nd
th
e S
up
ply
of
Ce
ntr
al B
an
k M
on
ey
REF
RES
H
At
the
cu
rre
nt
inte
rest
rate
, su
pp
ose
th
e s
up
ply
of
mo
ne
y is
le
ss t
ha
n t
he
de
ma
nd
fo
r m
on
ey.
Giv
en
th
is in
form
ati
on
, w
e k
no
w t
ha
t:
1)
the
pri
ce
of
bo
nd
s w
ill te
nd
in
cre
ase
.
2)
the
pri
ce
of
bo
nd
s w
ill te
nd
to
fa
ll.
3)
pro
du
cti
on
eq
ua
ls d
em
an
d.
4)
the
go
od
s m
ark
et
is a
lso
in
eq
uilib
riu
m.
5)
the
su
pp
ly o
f b
on
ds a
lso
eq
ua
ls t
he
de
ma
nd
for
bo
nd
s.
39
REF
RES
H
Th
e m
on
ey
de
ma
nd
cu
rve
will sh
ift
to t
he
le
ft
wh
en
wh
ich
of
the
fo
llo
win
g o
ccu
rs?
1)
a r
ed
ucti
on
in
th
e in
tere
st
rate
2)
an
in
cre
ase
in
th
e in
tere
st
rate
3)
an
op
en
ma
rke
t sa
le o
f b
on
ds b
y th
e c
en
tra
l
ba
nk
4)
an
in
cre
ase
in
in
co
me
5)
no
ne
of
the
ab
ove
40
SEE
YOU
NEX
T TI
ME -
�A
ssig
ne
d r
ea
din
g:
¾Te
xtb
oo
k C
ha
p.
4 (
4-3
an
d 4
-4 o
pti
on
al b
ut
ne
ed
to
kn
ow
th
e m
ate
ria
ls f
rom
le
ctu
re s
lid
es)
¾Te
xtb
oo
k, C
ha
p. 5
(fo
r n
ext
tim
e)
�P
rob
lem
se
t 2
will b
e p
oste
d o
n C
AN
VA
S.
41
