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Lecture 4 Financial Markets

The lecture on macroeconomics covers the demand for money and bonds, the supply of money, and the determination of interest rates, emphasizing the role of liquidity preference and the vertical nature of the money supply. It explains how nominal interest rates adjust to achieve equilibrium in the money market and outlines the objectives of monetary policy, particularly price stability in Zambia. The assignment asks students to describe the monetary policy tools used by the Central Bank of Zambia to control the money supply.

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14 views11 pages

Lecture 4 Financial Markets

The lecture on macroeconomics covers the demand for money and bonds, the supply of money, and the determination of interest rates, emphasizing the role of liquidity preference and the vertical nature of the money supply. It explains how nominal interest rates adjust to achieve equilibrium in the money market and outlines the objectives of monetary policy, particularly price stability in Zambia. The assignment asks students to describe the monetary policy tools used by the Central Bank of Zambia to control the money supply.

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EC122: MACROECONOMICS

LECTURER: Dr. KALUBI Ph.D.


(ECONOMICS)
FINANCIAL MARKETS
Here is what we shall look at in this lecture:
• Demand for money and bonds
• Supply of money
• Determination of the interest rate
• Monetary policy
Demand for money and bonds
A government bond is a debt instrument issued by the Government of Zambia through Bank
of Zambia. By issuing this instrument, the Government is borrowing money from the buyers
of this instrument; generally with a promise to pay periodic interest payments, and to repay
a face value on the maturity date. Government bonds are relatively long-term instruments
with a minimum period of two years.
THE PRICE of money is the nominal interest rate, THE QUANTITY is how much money
people hold, SUPPLY is the money supply, and DEMAND is the demand for money.
The tradeoff between keeping your assets liquid (in the form of cash) or in some other asset
(bonds) is called liquidity preference. The amount you are willing to hold in the form of
cash is going to depend on a lot of things, such as the price of food, how hungry you are,
and how easy it is to move wealth between cash and bonds.
Your liquidity preference will also depend on the interest rate. If the interest rate suddenly
went down to less than 1%, then holding onto these bonds doesn’t make as much sense as it
did at 10%. This inverse relationship between liquidity preference and the interest rate
means that the demand for money is downward sloping.
Money supply is vertical
• Money supply is ultimately determined by the monetary base and the money
multiplier. In most countries, that country’s central bank determines the size of
the monetary base. Remember that the monetary base includes reserves in vaults
and currency in circulation outside of banks. For example, central banks might
change the reserve requirements to change the monetary base.
• The money supply doesn’t depend on the interest rate, it only depends on the
central bank. Because of this, the money supply curve is vertical at the quantity
of the money supply, not upward sloping or downward sloping.
Nominal interest rate adjusts until the
money market is in equilibrium
• In any market, an equilibrium occurs when the quantity supplied is equal to the
quantity demanded. Prices adjust until the market is in equilibrium. The money
market is no exception.
• The price is the nominal interest rate. The supply curve is vertical (See slide 7).
• In the money market, the nominal interest rate adjusts until the quantity of
money that people want to hold is the same as the quantity of money that exists.
If the nominal interest rate is above equilibrium high, people reduce their
holdings of cash. If the nominal interest rate is below equilibrium, they increase
their holdings of cash. [Explain why this happens]
Money market
• The money market shows us how the demand for money and the supply of money interact to determine nominal interest
rates. Note that the demand for money ( ) is downward sloping and the supply of money is vertical ( and ).
• In the graph below, the money supply has increased. As a result of the increase in the money supply, the quantity of money
demanded at the old rate of interest ( ) is less than the money supply.
Do not get confused
• Do not get confused about what interest rate is represented in the money market:
real or nominal? It’s the nominal rate. Think of the nominal interest rate as the
interest rate on the sign outside of a bank. A sign that says, “Now paying higher
interest rates!” is advertising a higher nominal interest rate. The real interest rate
is that nominal interest minus the rate of inflation.
• It might also seem odd that the money supply curve is always perfectly vertical.
Keep in mind what the vertical money supply curve is saying: the central bank
determines the monetary base, and therefore the money supply. This money
creation might change interest rates, but it is not being done in response to
interest rates, so the supply of money is perfectly vertical.
Monetary policy
Monetary policy refers to the measures or actions taken by the monetary
authority of the country (the Bank of Zambia in this case) to alter the quantity,
availability and cost of money or credit in the economy.
Objectives Of Monetary Policy
The primary objective of monetary policy is Price stability. The price stability
goal is attained when the general price level in the domestic economy remains as
low and stable as possible in order to foster sustainable economic growth.
Instability in the general price level is undesirable as it brings about uncertainty
and instability in the economy, thereby discouraging investment and hampering
economic growth. In Zambia, the price stability objective is attained through the
achievement and maintenance of inflation within the target range of 6 to 8% over
the medium-term.
For more on monetary policy in Zambia visit the Bank of Zambia
website: https://www.boz.zm/monetary-policy.htm
RESEARCH QUESTION?
Describe the monetary policy tools used by the Central Bank of Zambia to
control the supply of money in the Zambian economy.

(Assignment to be submitted on Sunday via your respective humble servants)

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