The Determination of Interest Rates. Now, first, it's important to understand that interest rates are essentially the price of money. And just like all other markets and assets, the price of those assets are determined by supply and demand. And interest rates and money are no exception. And therefore, interest rates effectively adjust to bring both supply and demand for money into equilibrium. Now, you may be questioning the concept of demand for money. After all, we all have an infinite amount of demand to have more money, but this concept's a little different. In this sense, the demand for money is the amount of wealth that individuals hold in the form of money. So, that's in the form of currency. So, not invested in stocks, bonds, or other investments. And the amount of wealth that individuals want to hold in the form of money is determined by three factors. The first being for transaction purposes. Now, the amount individuals hold for transactions tend to increase as the average value of transactions in the economy increase. So, generally speaking, as the economy grows, as GDP grows over time, individuals will tend to hold more of their wealth in money for transactions. So, there's a positive relationship. The next is money as a safety net. So, it's precautionary, it's there to provide a buffer against any unforeseen event that may require money. Now, these per precautionary balances will also tend to rise with the volume and value of transactions in the economy and therefore, also positively related to GDP. And lastly, speculate. Now the speculative demand for money. And sometimes you'll hear a call portfolio demand for money relates to the demand to hold money based on potential investment opportunities or risks that are out there in other financial instruments. Therefore, the speculative demand for money tends to fall as the returns available in other financial assets or the perceived return in other financial assets increase. And the flip side is also true. The amount held to speculate will increase as the perceived risk in other financial increases also. So, in aggregate, speculative balances will tend to be inversely related to the expected return of other financial assets and directly related to the perceived risk of these financial assets. Well, now that we covered the demand for money, we can also take a look at the supply of money. And this is a bit of a review, but the government and the federal reserve essentially dictates the level of supply of money in the economy using three separate tools. Open market operations, discount rate and reserve requirements. But essentially the takeaway here is as the federal reserve increases money supply, it creates a stimulus to the economy. And when the government decreases the money supply using any of these three tools, it's essentially tightening monetary policy. Now, here's your typical supply and demand curve for the demand of money and supply of money. The vertical line is the money supply while the curve lined is money demand. Now, as you can see where they intersect is where we hit an equilibrium. Now let's think about it if we weren't an equilibrium. Let's say interest rates were above that level where they intersect. That would essentially create an excess supply of money. Therefore, people would seek to buy bonds with their excess money balances which would then force the price of bonds up and the interest rate down back towards that equilibrium level. Similarly, if bonds offered a rate that was below that equilibrium level, there would be an excess demand for money in that situation. And corporations and individuals, they would seek to sell their bond holdings so that they could increase their money holdings. And by doing so, the price of bonds would fall and interest rates would have to increase until it reaches that equilibrium level once again. Again, interest rates effectively adjust to bring the market into equilibrium and clear the market. As you all likely know, the government and the federal reserve have the ability to influence interest rates. And let's take a quick example here. Suppose the central bank, the federal reserve increases the money supply so that the vertical line shifts to the right. Because the increase in the supply of money makes it more plentiful, there's more of it out there,

And again, since interest rates are the price of money, interest rates will fall until it hits a new equilibrium level seen here.