Video transcript
Now that we know that wecan view interest rates as essentially the price of renting money. I want to go through a bunch of scenarios just so we can understandhow different things that happen in the economy mighteffect interest rates. I just draw a bunch ofsupply and demand curves right over here. Onceagain we're talking about the market for essentially renting money. That right over hereis the price of money, which we know is the interest rate on the vertical axis. Then thehorizontal axis we have the quantity of moneythat is borrow or lent in a given time period.Quantity and this is a given time period thatis borrowed or lent. Quantity borrowed in ayear. We know there is some ... if we just wantedto draw a demand curve our starting demand curve.The first few dollars out in the economypeople are willing to pay a very high interestrate on them. Then every incremental dollar afterthat people get less marginal benefit. Theymight not find as good of a place to put thatmoney. Their borrowing it for a reason. Theireither going to borrow to consume to buysomething that they always wanted that they thinkwill make them happy, or more likely theirborrowing it to invest it and hopefully getting areturn higher than what they are borrowing at. You have a marginal benefit curve that wouldbe downward sloping something like that.Maybe it looks something like that. That is ourdemand curve or our marginal benefit curve. The supply curve. Now,once again this is the exact same logic we usewith the demand and supply curve for any good or service. For money might looklike this. Those first few dollars someone hasa very low opportunity cost of lending it out,so, their willing to lend it out at a very low interest rate. Then every incrementaldollar after that theirs higher opportunity cost,and people will lend it out at a higher and higher rate. Then you have a marketequilibrium interest rate. Let me copy and pastethis. Then we could think about what happens in different scenarios. Copy and paste. Now wehave 2 scenarios that we can work on, and then letme just do 1 more. 3 scenarios. Let's think of a couple.Let's say that the central bank of our country, in the United States, that would be the FederalReserve, the central bank prints more money.Then decides to lend out that money. Thatactually is ... in the previous video I talkedabout the central bank printing money and then dropping it from helicopters, that is nothow money is actually distributed. It isdisturbed when central banks print money. The way thatit enters into circulation in most countries is that the central bank then goes and essentiallylends that money. The way it's done in the US Fed, most part they go out and buy government securities which is essentially lending money to the Federal Government. Theydo that because that's considered to be the safest investment. They go out there and they lend money. If this is our original supply curve. If this is our originalsupply curve, but now your Federal ... CentralBank is printing more money and lending it out.What is going to happen over here? Your supplycurve is going to shift to the right at anygiven price, at any given interest rate. Your going to have a larger quantity of money beingavailable. It might look something like ... yournew supply curve might look something like that. Assuming that's theonly change that happens you see its effect. Yournew equilibrium price of money, the rent onmoney, or the interest rate on money is nowlower. That's why when the Federal Reserves say Iwant to lower interest rates, they do so by printing money. They print that money,and they lend it out in the market. That essentiallyhas the effect of lowering interest rates. Let's think about another situation. Let's say this is the Fedprints and lends money. Their lending the money bybuying government bonds. When you buy a governmentbond, your essentially lending that money tothe Federal Government . I've done other videoson that where we go into a little bit more detail on that. Let's think of another situation. Let's think aboutconsumer savings go down. One interesting thingabout savings, savings and investment are twoopposite sides of the same coin. When you save money... you literally put it into a bank. Youhave the whole financial system right over here.This is the finincial system. Financial system.That money goes out and is lent to other people.For the most part, hopefully, that moneywhen it's lent is used to invest in someway. This is lending. If consumer savingsgoes down that means the supply of money willbe shifted to the left. At any given price andany given interest rate their be less money available. In this situation oursupply curve is shifting to the left. That wouldincrease interest rates. Then you could evenmake an argument that if consumers savings isgoing down consumers are going to borrow less as well. You could argue that maybe demandwould go up as well. Your demand could goup and that would make the equilibrium interestrate even even higher. Let's do another scenario.Let's say that the Federal Government inan effort to ... let's say that for whateverreason, their trying to finance a war or some typeof public works project and they don't want to raise taxes. The government decides toborrow a lot more money. The government is essentiallygoing expand it's deficit. The government is going to borrow money. Here our supply isn'tchanging. I'm assuming the Central Bank isn'tchanging it's policies, how much it's printing.Savings rates aren't changing. The demand is going to go up. Government is borrowingmoney. The government is going to borrow moremoney than it was already doing. At any given pricethe demand for money is going to increase. We're going to shift to the right, and ournew equilibrium interest rate, remember therental price of money, is going to go up. The whole point of thisis just to show you that you really can't thinkabout money like any other good or service. If thesupply of money goes up then the price ofmoney, which is interest rates, will go down.Let me write this down. If the supply goes upthen the price, which is just the interest rates goes down. If the demand goes up,then the price of money will go up. Interest rates will go up. Then we think about allthe other combinations where demand goes down,then interest would go down. Which is essentially just price. If supply went down,interest rates would go up. If something becomesmore scarce the price of it goes up. The wholepoint of this is just to show that it's not that complicated. You'll see people say,oh, government borrowing, it's crowding out othersavings, interest rates go up, and it soundslike something deep is happening. They are just talking about the supply and demand formoney. You just have to remember that interestrates really are nothing more than the rental price for money.
