Lecture 7 Froyen Ch 6 - Froyen Chapter 6 The Keynesian System(II Money Interest and Income Introduction In this chapter we will examine the role of

Lecture 7 Froyen Ch 6 - Froyen Chapter 6 The Keynesian...

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Froyen Chapter 6 The Keynesian System (II): Money, Interest and Income
Introduction In this chapter, we will examine the role of money and the rate of interest We are specifically interested in the way in which these variables affect AD in the Keynesian system Recall that in the Classical Model: Money determined the price level (QTM) The supply and demand for loanable funds determined the rate of interest Keynes rejected both of these ideas and put forward different theories of money and interest
Why Do Interest Rates Matter?
The Keynesian View of Interest Rate Determination On the surface, the Keynesian view of interest rate determination appears rather simplistic The interest rate equilibrates supply and demand for money The money supply is assumed to be fixed exogenously by the central bank at M 0 s But the theory becomes more complex when we consider the factors that affect the demand for money With M S exogenously given, the position of the M d curve will determine the rate of interest Shifts in either the M s or the M d curve will cause the interest rate to change M d M 0 s i M i 0
The Determinants of M d Since ∆M d ∆ “i” ∆I ∆Y, we must learn more about the determinants of M d Keynes rejected the Classical view of interest as the reward for saving money He argued that interest was the reward for parting with liquidity (i.e. “not hoarding” money) He suggested that there were three motives for holding money: + 1. Transactions Demand = ƒ (Y) + 2. Precautionary Demand = ƒ (Y) - 3. Speculative Demand = ƒ (i) Demand for money as an asset Desire cash balance in order to speculate about future movements in “i” Will demand more (less) cash today if interest rates are expected to rise (fall) Uncertainty

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