Financial Markets

• Money and other financial assets
• Interest Rate
• central banks and commercial banks
  • each country has their own central bank
  • e.g. FED in US
  • e.g. ECB in

Household Decisions

graph LR
A(Income)-->B(Taxes)
A(Income)-->C(Consumption)
A(Income)-->D(Saving)
D-->E(Wealth)
E-->F(Money demand)
E-->G(Other assets, eg bonds)

Fiscal Policy

• issued by government
• levels of government spending and taxes
  • also where the spending and taxing is happening

Monetary Policy

• issued by central bank
• changes in money supply
  • setting Interest Rate for a region

Market Operations

Money Demand

• the amount of money people want to hold, aggregated
  • in personal finance: non-dispensable income
• dependent on income and Interest Rate
  • $M^d=M^d(Y,i)$

Money Supply

• decided by central bank
• equilibrium = $M^s=M^d$
• therefore → $M^s=Y\ast L(i)$

Open Market Operations

• buying/selling own bonds
• increase money supply: expansionary open market operation
  • lower Interest Rate
  • buying of own bonds → Share Buyback, reducing available bonds
  • $\uparrow T$ and/or $\downarrow G$ → $\downarrow Z$ → $\downarrow Y$ → $\downarrow C,I$ → loop
    • government budget credit → lower GDP
• decrease money supply: consolidation/contractionary open market operation
  • higher Interest Rate
  • selling of own bonds → issuing additional bonds
  • $\uparrow G$ and/or $\downarrow T$ → $\uparrow Z$ → $\uparrow Y$ → $\uparrow C,I$ → loop
    • government budget debt → higher GDP
• no “setting” of interest rate
  • just selling/buying enough bonds to adjust interest rate accordingly
• interest rate increases when income $Y$ increases
• interest rate decrease when money supply $M^s$ increases

Fischer Equation

$r=i-{\pi }^e$ $r$ … real interest rate $i$ … nominal interest rate ${\pi }^e$ … expected inflation

Negative Real Interest

• $i$ can never be less than 0 → lower bound
• $r$ can only ever be negative (deflation) when $i<{\pi }^e$

Financial Crisis

• risk premium $x$ …todo
• response: fiscal policy and monetary rate

Unconventional Methods

• qualitative easing
• quantitative easing
  • buying bonds → more money in the economy
  • selling bonds → less money in the economy

Where does money come from

Central Banks

• assets
  • bonds (Open Market Operations)
• liabilities
  • central bank money (H)
  • currency (CU)
  • reserves (R)
  • NO EQUITY

Commercial Bank

• assets
  • loans
  • bonds
  • reserve at central bank
• liabilities
  • checkable deposits
  • equity

Money Multiplier