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8/8/2019 Demand for and Supply of Money-V
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Demand for Money,Demand for Money,
Supply of MoneySupply of Moneyand Monetaryand Monetary
PolicyPolicyDr. Shylajan, C.SDr. Shylajan, C.S
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Topicsof DiscussionTopicsof Discussion
Money SupplyMoney Supply
Money Stock MeasuresMoney Stock Measures
The Money Market: DD & SSThe Money Market: DD & SS The Demand for Money: Keynesian TheoryThe Demand for Money: Keynesian Theory
Determination of Interest Rates: ClassicalDetermination of Interest Rates: Classical vsvsKeynesian TheoryKeynesian Theory
Monitory Transmission Mechanism (ChangeMonitory Transmission Mechanism (Changein Monetary Policy and Impacts on Interestin Monetary Policy and Impacts on InterestRate, Consumption, Investment, AD andRate, Consumption, Investment, AD andGDP)GDP)
Nominal Vs Real Interest RatesNominal Vs Real Interest Rates
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Money SupplyMoney Supply--HowisitHowisit
defineddefined Money is a medium of exchange.Money is a medium of exchange.
It is what we use to make paymentsIt is what we use to make payments What is that we use to makeWhat is that we use to make
payments?payments?
Currency andCurrency and
Chequeable deposits with banksChequeable deposits with banks
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ComponentsofMoneyComponentsofMoney
SupplySupply Narrow Money (M1)Narrow Money (M1)
Broad Money (M3)Broad Money (M3) M1 = Currency with public + savingM1 = Currency with public + saving
(demand) deposits with banks + other(demand) deposits with banks + otherdeposistdeposist with RBI with RBI
M3 = M1 + time (fixed) deposits with banksM3 = M1 + time (fixed) deposits with banks
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Why dowe DemandWhy dowe Demand
MoneyMoney Role of Money in Classical Theory:Role of Money in Classical Theory:
Does not influence price, real interestDoes not influence price, real interest
rate and real income.rate and real income. Quantity theory of money: MV=PTQuantity theory of money: MV=PT
Keynesian Theory: 3 motivesKeynesian Theory: 3 motives
Transaction demand formoneyTransaction demand formoneyPrecautionary demand forPrecautionary demand formoneymoney
Speculative Demand forMoneySpeculative Demand for
Money
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Why dowe DemandWhy dowe Demand
MoneyMoneyTransaction demand formoneyTransaction demand formoney
PositivefunctionofincomePositivefunctionofincome NegativefunctionofinterestrateNegativefunctionofinterestrate
Precautionary demand formoneyPrecautionary demand formoney
PositivefunctionofincomePositivefunctionofincome
NegativefunctionofinterestrateNegativefunctionofinterestrate
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Why dowe DemandWhy dowe Demand
MoneyMoney Speculative Demand forMoneySpeculative Demand forMoney
Expected changeininterestratesExpected changeininterestrates Inshort, demand formoneyisaInshort, demand formoneyisanegativefunctionofinterestrateandnegativefunctionofinterestrateandpositivefunctionofincomepositivefunctionofincome
Stabilityof demand formoneyistheStabilityof demand formoneyisthekeytoproperconductofmonetarykeytoproperconductofmonetarypolicypolicy
MdMd==kY+fkY+f((ii))
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TheMoneyMarketandTheMoneyMarketandDeterminationofEquilibriumDeterminationofEquilibrium
RateofInterestRateofInterest
Interest rate: cost of borrowing moneyInterest rate: cost of borrowing money
How does the interest rate determined? (both inHow does the interest rate determined? (both inclassical and Keynesian theory)classical and Keynesian theory)
Supply of money and demand for moneySupply of money and demand for money Interest rate is set by the intersection of DD forInterest rate is set by the intersection of DD for
and SS of moneyand SS of money
MdMd=Ms=Ms
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Interest RatesInterest Rates
Consumers and investors rely onConsumers and investors rely on
money for purchase of goods andmoney for purchase of goods andservices.services.
Monetary authority can augment AD orMonetary authority can augment AD orreduce ADreduce AD bychangingmoneybychangingmoneysupplyand therebyinterestrates.supplyand therebyinterestrates.
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ChangeinMonetaryChangeinMonetary
PolicyPolicy Monetary authority may follow aMonetary authority may follow a
EasymonetarypolicyorEasymonetarypolicyor
TightmonetarypolicyTightmonetarypolicy
What is easy and tight monetary policy?What is easy and tight monetary policy?
Easy Monetary Policy money supplyEasy Monetary Policy money supplygrowth increases..interest rate declinegrowth increases..interest rate decline
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ChangeinMonetaryChangeinMonetary
PolicyPolicy
Then what happens to demand forThen what happens to demand formoney?money?
Demand for money will increase andDemand for money will increase and
Then spending on goods and servicesThen spending on goods and servicesincreasesincreases
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ChangeinMonetaryChangeinMonetary
PolicyPolicy Tight Monetary Policy..money supplyTight Monetary Policy..money supply
growth falls..interest rate increasesgrowth falls..interest rate increases
Then demand for money will fall..soThen demand for money will fall..sospending on goods and services fallsspending on goods and services falls
What kind of monetary policy RBI isWhat kind of monetary policy RBI isfollowing now?following now?
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ChangeinMonetaryChangeinMonetaryPolicyand ImpactsPolicyand Impacts--GraphicallyGraphically
ADAD--AS frameworkAS framework
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Nominal Vs RealNominal Vs Real
Interest RatesInterest Rates Real interest rate = Nominal interestReal interest rate = Nominal interest
rate minus rate of inflationrate minus rate of inflation
12% nominal interest rate12% nominal interest rate 3%3%inflation rate =9 % real interest rateinflation rate =9 % real interest rate
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TheMoneySupplyTheMoneySupply
ProcessProcess What causes change in money supply?What causes change in money supply?
M = C + DM = C + D
Where M is money stock, C is currency withWhere M is money stock, C is currency withpublic and D is bank depositspublic and D is bank deposits
Three groups influence money supplyThree groups influence money supplygrowthgrowth
1. Central bank1. Central bank2.Commercial Bank2.Commercial Bank
3. Public3. Public
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MoneyMultiplierMoneyMultiplier
Money multiplier (m) = M3/HMoney multiplier (m) = M3/H
M3 = Currency with Public + DepositsM3 = Currency with Public + Deposits
High powered money = Currency + ReservesHigh powered money = Currency + Reserves
Where m is money multiplierWhere m is money multiplier
M3 is total money supplyM3 is total money supply
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ControlofMoneySupplyControlofMoneySupply
by RBIby RBIInstrumentsofControlInstrumentsofControl
Changing Reserve Requirements (CRR, forChanging Reserve Requirements (CRR, forinstance)instance)
Changing the Bank RateChanging the Bank Rate
Direct Credit ControlsDirect Credit Controls
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MonetaryPolicyMonetaryPolicy
TransmissionMechanismTransmissionMechanismMoney supply changeMoney supply change
Effect on interest rate rEffect on interest rate r Impact on business spendingImpact on business spending
Impact on consumer spendingImpact on consumer spending Impact on Output or GDPImpact on Output or GDP
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MonetaryPolicyintheMonetaryPolicyintheADAD--AS FrameworkAS Framework
Two CasesTwo Cases
The case of increase in AD where potentialThe case of increase in AD where potentialoutput is not achievedoutput is not achieved
The case of increase in AD and its impact onThe case of increase in AD and its impact onoutput and price when potential output isoutput and price when potential output isreachedreached
Graphical approachGraphical approach
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MonetaryPolicyinIndiaMonetaryPolicyinIndia
Changes in major Monetary PolicyChanges in major Monetary PolicyMeasures:Measures:
Bank RateBank Rate
Cash Reserve Ratio (CRR)Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)Statutory Liquidity Ratio (SLR)
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MonetaryPolicyinMonetaryPolicyin
IndiaIndia Bank RateBank Rate in 1999:in 1999: 12 %12 % In 2003In 2003 :: 6 %6 %
In 2007In 2007 :: 6%6%
CRRCRR in 1991in 1991 :: 15 %15 % In 2004In 2004 :: 5 %5 %
In 2007In 2007 :: 7.50%7.50%
SLRSLR in 1992in 1992 :: 38.5 %38.5 % In 1997In 1997 :: 25 %25 %
In 2007In 2007 :: 25 %25 %
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SummarySummary
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