Macroeconomic Policies Notes (Incomplete)

H2 Economics Chapter 11, 12 and 13 Notes This document is intended as a summary of the points provided in the NJC 2024 H2 Economics Chapter 11, 12 and 13 Seminar Notes. It is to be used as a study guide to provide a structure for studying the Chapter 11, 12 and 13 Notes. 1 Interest Rate Monetary Policy 1.1 Theory of Liquidity Preference Keynes proposed that money can be treated like a commodity in his Theory of Liquidity Preference. Similar to how goods and services are bought by consumers from producers, there is a market for money, as money can be ‘bought’ by households and firms for a ‘price’. This price is more commonly known as the interest rate of a country’s central bank. Liquidity Preference is the preference for holding money 1 over other kinds of assets. Why do we use the term ‘other kinds of assets’? People store their wealth not only in terms of money but also other financial assets such as bonds and stocks. A reduction in the quantity of money in circulation does not translate to money simply disappearing. Instead, people convert their money into assets so that they retain their wealth while holding less money. The Liquidity Preference (Money Demand) Curve There are three main purposes for holding money. Should a question require explanation on determinants of liquidity preference, it is important to link to these concepts. (1) Transactionary Purpose: Money needed to facilitate payment for daily transactions of goods and services. (2) Precautionary Purpose: Money held as a precaution for unexpected items of expenditures like sickness or accidents. (3) Speculative Purpose: Money held instead of investing it in bonds or other assets. You can think of this as money that is held because it is not worth it to buy other assets.) 1 Holding money refers to the act of keeping cash readily available instead of investing or spending it immediately. A portion of one's wealth is held in the form of currency or cash equivalents, such as deposits in bank accounts or physical currency. 1

NJC H2 Economics 2024 Chapter 11/12/13 As the government increases interest rates, the cost of borrowing 2 money from the bank increases since a borrower would have to repay a greater sum of money in the future than if the interest rate was lower. Hence, households and firms would borrow less money. Conversely, if the interest rate was lowered, more money would be borrowed. This inverse relationship bet