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Equilibrium interest

rate → Ms = Md

The interest rate must be such that the money supply (independent of the interest rate) is equal to the money demand (depends on the interest rate)

    • Increase in nominal income

    • Md shifts to the right and Ms

remains fixed

    • Interest rates move higher

right and Md remains fixed

    • Interest rates move lower

    • This is what is happening right now since Deposit Rates>Loan demand

  • The Central Bank injects or sucks out money from the system by

buying or selling Govt. bonds in the bond market

  • Expansionary Monetary Policy

  • Injection of liquidity: Buys Govt bonds and broadly fixed securities from financial market players like Banks, FIs, Pension fund (from household savings), Corporate treasuries (cash surplus) etc. and releases rupees.

  • These bonds get added to the CB balance sheet as ‘assets’

  • The money that these players receive as payment for selling the bonds is the currency that the CB creates in the system which added to the CB ‘liabilities’

  • Contractionary monetary policy

  • CB sells Govt bonds to market players for the amount of money

supply that you want to reduce

and the money that it receives from these players, that much

‘liability’ does down

able to suck money out of the system. It sells to primary dealers

  • Open market operations (OMO) because they take place in the

“open market” for bonds, or what we call as the secondary market.

  • Explain what happens in Contractionary monetary policy

Monetary aggregates –

Base money & broad money

  • 3 main types of money in fiat money economy:

  1. Currency

  2. Bank deposits

  3. Central bank reserves

  • Each represents an IOU from one sector of the economy to

another broadly split into:

  1. Central Bank

  2. Commercial Banks

  3. Private HHs & companies

created by commercial banks themselves

  • To formally measure the money circulating in economy, Central Banks compile monetary aggregates

  1. Base Money

  2. Broad Money

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