The Behavior of Interest Rates Chapter 5 The Behavior of Interest Rates

Determining the Quantity Demanded of an Asset Wealth(財富): the total resources owned by the individual, including all assets Expected Return(預期報酬): the return expected over the next period on one asset relative to alternative assets Risk(風險): the degree of uncertainty associated with the return on one asset relative to alternative assets Liquidity(流動性): the ease and speed with which an asset can be turned into cash relative to alternative assets

Theory of Asset Demand (資產需求理論) Holding all other factors constant(當其他一切因素不變時): The quantity demanded of an asset is positively related to wealth(財富) The quantity demanded of an asset is positively related to its expected return(預期報酬) relative to alternative assets The quantity demanded of an asset is negatively related to the risk (風險) of its returns relative to alternative assets The quantity demanded of an asset is positively related to its liquidity(流動性) relative to alternative assets

Summary Table 1 Response of the Quantity of an Asset Demanded to Changes in Wealth, Expected Returns, Risk, and Liquidity

Supply and Demand for Bonds At lower prices (higher interest rates), ceteris paribus(其他一切不變), the quantity demanded of bonds is higher: an inverse relationship At lower prices (higher interest rates), ceteris paribus, the quantity supplied of bonds is lower: a positive relationship

Figure 1 Supply and Demand for Bonds

Loanable Funds Terminology 1. Demand for bonds = supply of loanable funds 2. Supply of bonds = demand for loanable funds

Market Equilibrium Occurs when the amount that people are willing to buy (demand) equals the amount that people are willing to sell (supply) at a given price Bd = Bs defines the equilibrium (or market clearing) price and interest rate. When Bd > Bs , there is excess demand, price will rise and interest rate will fall When Bd < Bs , there is excess supply, price will fall and interest rate will rise

借貸市場均衡交易量--單位：新台幣億元；％ 民　國 全　體　貨　幣　機　構　放　款　與　投　資　對　象　別 金融機構 金融業 拆款市場 短 期 票 券 市 場 債　券　市　場13 股　票　市　場 外 匯 市 場 Loans & investments of monetary financial institutions (by sector) 淨超額準備 Interbank market call-loan Short-term bills market Bond market Stock market Foreign exchange market 合　　　　　計 對 政 府 債 權 對公營事業債權 對民間部門債權11 Free reserves 期底拆款餘額 當期拆款金額 期底發行餘額 12 當期交易金額 期底發行餘額 總 市 值 當期成交金額 全體外匯交易 年　月 Total Claims on government Claims on private of financial Amount Total trading Total trading value 日平均淨額 enterprises sector institutions (end of value outstanding market trading (百萬美元) 期底餘額 年增率 超額( + ) period) (during the 買賣斷交易 Annual Excess (+) or Outright Averages of daily growth 不足( - ) transaction trading value rate shortage (-) (US million) 95 201,539 4.10 30,337 2.31 6,446 - 2.58 164,756 4.72 + 59 2,564 238,389 10,924 485,513 54,621 2,758,332 1,699,920 193,770 239,004 15,632 96 206,269 2.35 29,209 - 3.72 7,164 11.14 169,896 3.12 + 195 2,007 202,383 9,253 431,962 55,421 1,940,055 937,876 215,273 330,439 18,623 97 213,315 3.42 30,407 9,980 39.31 172,928 1.78 + 298 1,606 166,097 9,698 462,041 57,712 1,355,095 597,490 117,065 261,154 19,367 98 214,823 0.71 34,691 14.09 9,167 - 8.14 170,965 - 1.13 + 954 1,980 257,072 10,431 420,964 59,203 975,475 394,047 210,336 296,805 16,222 99 228,037 6.15 35,833 3.29 9,769 6.56 182,435 6.71 + 258 2,299 354,794 11,675 371,564 63,523 1,063,180 426,516 238,114 282,187 20,232 100 241,729 6.00 37,454 4.52 10,442 6.89 193,834 6.25 + 140 1,628 326,936 11,926 396,139 68,958 978,091 268,567 192,162 261,974 24,169 101 255,488 5.69 41,050 9.60 10,654 2.03 203,784 5.13 + 171 2,483 348,763 14,540 386,884 75,761 865,517 184,358 213,522 202,382 23,408 102 267,206 4.59 41,800 1.82 11,098 4.17 214,309 5.16 + 331 3,807 398,431 16,502 365,545 81,046 692,261 136,953 245,196 189,409 28,929 103 281,106 5.20 44,033 5.34 10,585 - 4.62 226,488 5.68 + 299 2,858 479,346 16,412 356,760 87,268 680,324 147,060 268,915 218,985 31,290 104 r 294,064 4.61 46,186 4.89 10,761 1.66 237,117 4.69 + 326 2,818 486,966 16,777 332,633 88,595 677,257 154,143 245,036 201,915 … 資料來源：中央銀行金融統計月報

借貸市場均衡價格 資料來源：中央銀行金融統計月報 民 國 民　國 利率(年息百分比率) Interest rates (percent per annum) 股票市場 外匯市場 支票存款 退票17 國際收支(百萬美元)18 外匯存底 (百萬美元) 本國銀行19 逾放比率 消費者 物價指數 年增率 中 央 銀 行 利 率 銀 行 業 利 率 14 金融業 拆款市場 短期票券 市場 債券市場 股價指數 期底銀行間 年回轉次 張數比率 Balance of payments (US million) (民國 收盤美元 (次) Central bank rates Rates by banks Interbank Short-term Bond ５５年 (新台幣元) (期底) call loan bills market market =１００) 經常帳 資本帳與金融帳 準備資產變動 (end of period) 年　月 重貼現率 擔保放款 一個月期 一年期 存款牌告 利率 基準15 隔夜拆款加 商業本票 十年期中央 16 Stock Annual Dishonored Current account Capital and financial Changes in Foreign Non-performing 融通利率 存款牌告 放款利率 權平均利率 31-90天期 政府公債 price closing rate of check ratio balance account balance reserve exchange loan growth Discount Interest 利率 Weighted 次級市場利率 index spot turnover in number 商品貿易 直接投資 證券投資 assets reserves ratio of rate rate on 1-month 1-year Base averages of 31-90 days 10-year gov't in checking (%) Trade Direct Portfolio (US million) domestic consumer accommodations deposit lending overnight CP rates in bond rates in (１９６６ accounts investment banks prices with rates interest secondary =１００） (NT $/US$) collateral 95 2.750 3.125 1.71 2.20 4.115 1.552 1.54 1.98 6,842 32.5960 323.6 0.49 24,976 22,892 - 19,719 25 - 18,965 - 6,086 266,148 2.13 0.60 96 3.375 3.750 2.09 2.62 4.313 1.998 1.90 2.32 8,510 32.4430 316.1 0.43 33,762 29,072 - 39,028 - 3,338 - 40,062 4,020 270,311 1.84 1.80 97 2.000 2.375 0.91 1.42 4.205 2.014 1.92 2.29 7,024 32.8600 324.6 0.38 26,367 17,359 - 1,975 - 4,855 - 12,250 - 26,274 291,707 3.52 98 1.250 1.625 0.47 0.89 2.563 0.109 0.24 1.51 6,460 32.0300 253.8 0.30 41,933 29,582 13,392 - 3,072 - 10,327 - 54,126 348,198 1.15 - 0.86 99 0.67 1.13 2.676 0.185 1.37 7,950 30.3680 239.4 0.19 38,442 25,102 - 455 - 9,082 - 20,664 - 40,173 382,005 0.61 0.96 100 1.875 2.250 0.88 1.36 2.882 0.341 0.70 1.38 8,156 30.2900 240.0 0.17 39,908 26,545 - 32,146 - 14,723 - 35,691 - 6,239 385,547 101 2.883 0.428 0.79 1.21 7,481 29.1360 241.7 0.18 49,015 29,916 - 31,737 - 9,930 - 42,091 - 15,484 403,169 0.40 1.93 102 0.386 0.69 1.46 8,093 29.9500 235.3 55,309 35,452 - 43,909 - 10,687 - 28,834 - 11,318 416,811 103 0.387 0.62 1.60 8,992 31.7180 231.8 65,417 41,532 - 52,856 - 9,872 - 44,224 - 13,015 418,980 0.25 1.20 104 r 0.74 2.829 0.353 0.58 1.39 8,959 33.0660 249.2 -- 426,031 0.23 - 0.31

Shifts in the Demand for Bonds Wealth: in an expansion with growing wealth, the demand curve for bonds shifts to the right Expected Returns: higher expected interest rates in the future lower the expected return for long-term bonds, shifting the demand curve to the left Expected Inflation: an increase in the expected rate of inflations lowers the expected return for bonds, causing the demand curve to shift to the left Risk: an increase in the riskiness of bonds causes the demand curve to shift to the left Liquidity: increased liquidity of bonds results in the demand curve shifting right

Figure 2 Shift in the Demand Curve for Bonds

Summary Table 2 Factors That Shift the Demand Curve for Bonds

Shifts in the Supply of Bonds Expected profitability of investment opportunities(投資機會的預期獲利): in an expansion, the supply curve shifts to the right Expected inflation(預期通貨膨脹): an increase in expected inflation shifts the supply curve for bonds to the right Government budget(政府預算): increased budget deficits shift the supply curve to the right

FIGURE 3 Shift in the Supply Curve for Bonds

Summary Table 3 Factors That Shift the Supply of Bonds

Summary Table 3 Factors That Shift the Supply of Bonds

FIGURE 4 Response to a Change in Expected Inflation

Figure 5 Expected Inflation and Interest Rates (Three-Month Treasury Bills), 1953–2011 Source: Expected inflation calculated using procedures outlined in Frederic S. Mishkin, “The Real Interest Rate: An Empirical Investigation,” Carnegie-Rochester Conference Series on Public Policy 15 (1981): 151–200. These procedures involve estimating expected inflation as a function of past interest rates, inflation, and time trends.

Figure 6 Response to a Business Cycle Expansion

Figure 7 Business Cycle and Interest Rates (Three-Month Treasury Bills), 1951–2011 Source: Federal Reserve: www.federalreserve.gov/releases/H15/data.htm.

Supply and Demand in the Market for Money: The Liquidity Preference Framework (流動性偏好架構)

Figure 8 Equilibrium in the Market for Money

貨幣總計數 Monetary aggregates 貨幣總計數-- 單位：新台幣百萬元 民 國 全體貨幣機構以外各部門持有通貨 存款貨幣 Deposit money 準貨幣 Quasi-money 貨幣總計數 Monetary aggregates 計 支票存款1 活期存款 活期儲蓄存款 定期及定期 外匯存款2,3 郵政儲金4 外國人5 附買回6 貨幣市場7 Ｍ１Ａ Ｍ１Ｂ Ｍ２2,3 儲蓄存款2 新台幣存款 交易餘額 共同基金 年 月 底 Currency Subtotal Checking Passbook Time & Foreign Postal Non-residents Repurchase Money market held by the accounts deposits savings currency NTD deposits agreements mutual funds public (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)=(1)+(3)+(4) (14)=(13)+(5) (15)=(14)+(6) 95 12 758,721 7,463,905 368,535 1,942,742 5,152,628 17,445,600 11,007,545 1,693,697 4,002,250 224,672 513,012 4,424 3,069,998 8,222,626 25,668,226 96 12 762,627 7,457,350 321,284 2,072,730 5,063,336 17,663,127 10,950,331 1,939,493 4,039,656 307,889 422,669 3,089 3,156,641 8,219,977 25,883,104 97 12 833,537 7,320,167 316,928 2,071,833 4,931,406 19,601,771 12,425,064 2,320,607 4,232,126 196,776 424,538 2,660 3,222,298 8,153,704 27,755,475 98 12 912,618 9,598,968 337,260 2,674,529 6,587,179 18,843,976 11,611,179 2,341,112 4,421,531 197,349 270,851 1,954 3,924,407 10,511,586 29,355,562 99 12 995,853 10,461,273 352,769 2,935,099 7,173,405 19,497,303 11,855,188 2,575,206 4,498,514 222,924 344,063 1,408 4,283,721 11,457,126 30,954,429 100 12 1,107,344 10,722,872 407,865 3,013,953 7,301,054 20,621,704 12,722,399 2,678,404 4,656,799 213,058 349,438 1,606 4,529,162 11,830,216 32,451,920 101 12 1,203,212 11,215,168 410,493 3,128,026 7,676,649 21,156,024 12,930,079 2,875,311 4,924,124 199,244 226,680 586 4,741,731 12,418,380 33,574,404 102 12 1,329,651 12,141,101 380,553 3,548,807 8,211,741 22,048,111 13,054,177 3,475,115 5,139,278 189,981 188,892 668 5,259,011 13,470,752 35,518,863 103 12 1,460,904 12,849,182 392,702 3,715,570 8,740,910 23,386,754 13,345,355 4,160,474 5,469,587 194,558 216,484 296 5,569,176 14,310,086 37,696,840 104 r 12 1,565,415 13,727,172 386,245 4,108,659 9,232,268 24,591,408 13,773,446 4,696,000 5,738,129 177,809 205,758 266 6,060,319 15,292,587 39,883,995 資料來源：中央銀行金融統計月報

Demand for Money in the Liquidity Preference Framework As the interest rate increases: The opportunity cost of holding money(持有或幣的機會成本) increases… The relative expected return of money(貨幣的預期報酬) decreases… …and therefore the quantity demanded of money decreases.

Changes in Equilibrium Interest Rates in the Liquidity Preference Framework Shifts in the demand for money: Income Effect(所得效果): a higher level of income causes the demand for money at each interest rate to increase and the demand curve to shift to the right Price-Level Effect(價格水準效果): a rise in the price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right

Shifts in the Supply of Money Assume that the supply of money is controlled by the central bank(中央銀行) An increase in the money supply engineered by the Federal Reserve will shift the supply curve for money to the right

Figure 9 Response to a Change in Income or the Price Level

Figure 10 Response to a Change in the Money Supply

Summary Table 4 Factors That Shift the Demand for and Supply of Money

Price-Level Effect (價格效果) and Expected-Inflation Effect(預期通膨效果 A one time increase in the money supply will cause prices to rise to a permanently higher level by the end of the year. The interest rate will rise via the increased prices. Price-level effect remains even after prices have stopped rising. A rising price level will raise interest rates because people will expect inflation to be higher over the course of the year. When the price level stops rising, expectations of inflation will return to zero. Expected-inflation effect persists only as long as the price level continues to rise.

Does a Higher Rate of Growth of the Money Supply(貨幣成長率較高) Lower Interest Rates(降低利率)? Liquidity preference framework leads to the conclusion that an increase in the money supply will lower interest rates: the liquidity effect(流動性效果). Income effect(所得效果) finds interest rates rising because increasing the money supply is an expansionary influence on the economy (the demand curve shifts to the right).

Does a Higher Rate of Growth of the Money Supply Lower Interest Rates Does a Higher Rate of Growth of the Money Supply Lower Interest Rates? (cont’d) Price-Level effect predicts an increase in the money supply leads to a rise in interest rates in response to the rise in the price level (the demand curve shifts to the right). Expected-Inflation effect shows an increase in interest rates because an increase in the money supply may lead people to expect a higher price level in the future (the demand curve shifts to the right).

Figure 11 Response over Time to an Increase in Money Supply Growth

Figure 12 Money Growth (M2, Annual Rate) and Interest Rates (Three-Month Treasury Bills), 1950–2011 Sources: Federal Reserve: www.federalreserve.gov/releases/h6/hist/h6hist1.txt.