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Up8
Which of the following statements about the demand and supply of money is most accurate? People who are:
A)
holding money when interest rates are higher will try to reduce their money balances and, as a result, the demand for money decreases.
B)
buying bonds to reduce their money balances will increase the demand for bonds with an associated increase in interest rates.
C)
holding money when interest rates are lower will try to increase their money balances and, as a result, the supply of money increases.
Explanation
Buying bonds would drive bond prices up and interest rates down. Selling bonds would have the opposite effect; driving bond prices down and interest rates up. When interest rates are lower, there is an excess demand for money. The supply of money is determined by the monetary authorities.
(Study Session 5, Module 16.1, LOS 16.d)
Why is the answer A? Why is the Demand for money DOWN when interest rates are high? When Ally bank offered me 2.5% years back – I gladly took that interest each month. Now interest rates are around 1% on Ally in which I AM INCENTIVIZED TO INVEST IN THE MARKET OR SOMEWHERE WHERE I CAN EARN A BETTER RATE OF RETURN.
That said, my demand is lower when interest rates are down. What am I missing?
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Up2
Think about it, when interest rates are high, you’re going to hold more bonds because you earn a return on it. But when interest rates are low, you’d rather hold money instead of bonds so when interest rates are low, the demand for holding money is higher. But when interests are high the demand for holding bonds, or putting money into a CD, etc is higher. Does that make sense?
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