Chapter 5 The behavior of interest rate For

Chapter 5 The behavior of interest rate

• For me it is quite difficult to understand the demand supply argument, especially when the effects of one factor on demand supply are not discussed simultaneously.

demand of bond • • Wealth expected return Risk liquidity

Supply for bond • expected profitability of investment opportunities, • expected inflation • government activities

Liquidity Preference Framework • Demand – Income effect – Price level effect • Supply – Monetary policy from Bank of Canada

An Alternative Understanding • Reference rate • scarcity – Scarcity of current and future money • Risk return relation: CAPM

reference rate • The Fisher Effect – Higher inflation, higher interest rate – Don’t have to bother with shift in demand supply curve, which have to translate back to interest rate again. – Who is Irving Fisher? – A student of Willard Gibbs, one of the founders of statistical mechanics

• expected profitability of investment opportunities – Higher return, higher interest rate

reference rate • Low Japanese Interest Rate – The return on Japanese investment was low after the bubble – Housing price drop continuously

Scarcity • Low saving rate, high interest rate? – Low saving rate, scarcity of current money • Change in income – Income rising, scarcity of money supply • Change in price level – Higher price, less real money available • Change in money supply – More money, less scarce, but higher expected inflation

Relation between income, price level and money supply

Homework • 6, 8, 11, 13, 15, 17