In this case yes. What Wachtel is explaining in this case is how member
banks (as opposed to the central bank) behave in regard to the relation
between the discount rate and r. If a bank is going to command a higher
profit for a loan the higher the differential between the discount rate
and r the more money the member banks will borrow from the Federal Reserve
to loan to customers thereby creating more money. This action creates
movement -ALONG- the Money Supply Curve.
Let's take a look at the Money Supply Curve. The money supply curve is
determined by the following variables: Reserve Requirement Ratio (k),
Securities the central bank holds (Q), the currency (C) and excess reserves
(RE) the central Bank holds, and Borrowing which is a function of the
discount rate and r. The only variable that is dependent on r is the
borrowing function and all the rest are dependent on other factors.
Assume that borrowing does not exist. All that is left are
variables that are constant IN RESPECT TO r. Therefore, without borrowing
the Money Supply Curve would be VERTICAL in this case. Whatever happens in
the central bank only determines the Money Supply. The demand for money
will only determine the interest rate and have NO EFFECT on the money
supply. This assumes the central bank does nothing. Now replacing the
borrowing function, if money demand increases (shifts right) the interest
rate AND the quantity of money will increase. But this all assumes the Fed
sits idle.
> But, on page 115, when he is describing open market operations, he states,
> ". . .open market sales will push down the price of government bonds which
> raises interest rates. . . If reserves are in short supply, the banks will
> raise the price of borrowing, loan rates go up."
> To me, this says, if the money supply decreases, interest rates go up.
> This makes more sense, but it seems to contradict pg 107. So, when
> interest rates go up, does the money supply go up or down?
In the case of monetary policy being set by the central bank the
money supply curve actually SHIFTS. If the Fed moves the discount rate, it
will effect the value the borrowing function since the function is
dependent on both the discount rate and r. It may change its slope,
intercept, or both. I do not believe that Wachtel goes into it though. It
looks to be very complicated though because it appears that a discount
rate change will change r and the borrowing function is hit twice. Now to
how Emperor Greenspan most common tool of monetary policy: Open Market
Operations. When the Fed buys Treasuries, this will drive the price upward
due to simple supply and demand of a security. And since bond prices and
interest rates are inversely related the interest rate falls. Also the Fed
is injecting money (or creating additional reserves) into the system,
increasing the money supply. This is reflected as an increase in Q in the
money supply equation. When the Fed sells Treasuries, as in the example
you quoted out of Wachtel, the price will drop and rate will rise. In
addition, the Fed is draining money out of the system (or reducing the
amount of reserves) thereby decreasing the money supply. This is reflected
as a decrease in Q in the money supply equation. When he includes a member
bank is a little confusing to me also; but, I believe that this is what
happens: The Fed sells Treasuries; entities that have deposits in member
banks take their money out of the member bank and give it to the Fed; the
reserves become scarce for the current demand thereby rating a higher rate
of interest.
The two statements that seemed contradictory is just the
difference between moving ALONG the supply curve and the SHIFTING of the
supply curve.
Jo Dee, I hope this helps you out. And if you have any other
questions, please feel free to let me know. Explaining concepts to others
helps me understand it better.
James M. Smieszkal