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Unformatted text preview: ng other ways, by banks creating new deposits, that is, by an increase in the supply of money circulating in the economy. Thus the fall in interest rates as banks expand loans and investments is associated with an increase in the supply of money to the economy. By the same token, a smaller stock of money is associated with higher interest rates. This behavior is consistent with what economists know about the way the public manages its cash holdings. Currency and checkable deposits either do not pay interest at all, or pay rates that for the most part are below market yields. keeping part of one's funds tied up in money therefore is expensive because it means foregoing a market yield on those funds. For that reason, businesses and households try to get by with lower cash balances when market rates of interest are high, and they are willing to keep larger amounts of money on hand when interest rates are low. Economists call the amount of cash balances businesses and households want to hold the economy's demand for money. As we have just noted, this demand for money has been observed to be negatively related to market interest rates. That is, the higher are
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market rates, the lower is the amount of cash balances the public wants to hold, or, as economists would say, the lower is the quantity of money demanded by the public. By the same token, low interest rates mean a higher demand to hold money. This negative relationship between money demand and interest rates means that an increase in the amount of money circulating in the economy–in the supply of money in other words–should lower interest rates, because if it did not, the public would find itself holding money in excess of what it wants to hold or “demand.” The process by which rates are lowered has already been described: the new money is lent out by banks, adding to credit availability in the economy and causing interest rates to fall. Conversely, a lower supply of money means tighter credit and higher interest rates. If this money d...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10