Upload
gypsy-heart
View
242
Download
0
Embed Size (px)
Citation preview
8/12/2019 MONETARY THEORY.pdf
1/34
MonetaryTheory
What determines the demand for
money?Effects of changes in money supply.Channels of influence of monetary
policy
8/12/2019 MONETARY THEORY.pdf
2/34
Money Supply andEconomic Activity
How do changes in money supply affect
the economy? Short-run analysis: price level fixed,
output below the economys capacity
8/12/2019 MONETARY THEORY.pdf
3/34
Velocity of Circulation
Equation of exchangeMV = PY
M - money supplyV - velocity of circulation
P - price levelY - real gross national product Its an IDENTITY
8/12/2019 MONETARY THEORY.pdf
4/34
Effects of increase in money
supply One or more of
rise in real output rise in prices fall in velocity of circulation
8/12/2019 MONETARY THEORY.pdf
5/34
Demand for Money
Equilibrium: demand for money mustequal supply of money
What determines the demand formoney?
What services does money provide: medium of exchange store of value unit of account
8/12/2019 MONETARY THEORY.pdf
6/34
Why do people hold money
Transactions demand to be able to carry out normal buying and
selling
liquidity -- ability to buy and sell goodsimmediately applies to cash (notes and coins), current
accounts, and instant-access savings
As an asset applies also to non-instant access savings
accounts (time deposits)
8/12/2019 MONETARY THEORY.pdf
7/34
Cost of holding money Interest lost on less liquid assets with
higher returns -- stocks, bonds, longer-term bank deposits, etc -- is the price ofliquidity
Opportunity Cost! Cash pays a zero interest rate and
current accounts generally pay a very
tiny one. Demand for money should depend
negatively on the opportunity cost of
holding it --other things being equal
8/12/2019 MONETARY THEORY.pdf
8/34
Income, Wealth, and the
Demand for Money Transactions demand for cash depends
on how much you buy and sell High income/high spending people need
more cash / bank deposits People with more wealth may hold more
as part of their portfolio of assets(property/ stocks/bonds/pension funds/bank deposits/etc)
8/12/2019 MONETARY THEORY.pdf
9/34
8/12/2019 MONETARY THEORY.pdf
10/34
Equilibrium between thesupply and demand for money
Nominal interest rate adjusts to bringsupply and demand into balance
Increase in money supply -- people findmoney holding have gone up
Peoples attempts to invest in other
assets -- bonds, stocks, etc -- pushesup bond and share prices, and reducesreturns on them
Causes lower interest rates
8/12/2019 MONETARY THEORY.pdf
11/34
Determination of rate of
interest Note that here the interest rate balances
supply and demand for money Compare with the full employment
model interest rate balances supply of and
demand for saving In the unemployment /sticky price
model, saving / investment balance
determines the level of income
8/12/2019 MONETARY THEORY.pdf
12/34
8/12/2019 MONETARY THEORY.pdf
13/34
Effect of monetary policy onthe economy
Suppose the central bank raises themoney supply
Lower interest rate stimulatesinvestment
Higher investment stimulates higherincomes
Higher incomes raise the demand formoney, and cause interest rates to rise(relative to their new lower level) --
offsets part of original effect
8/12/2019 MONETARY THEORY.pdf
14/34
8/12/2019 MONETARY THEORY.pdf
15/34
8/12/2019 MONETARY THEORY.pdf
16/34
An increase in the money supply stimulates investment, raises theaggregate expenditure schedule, and thus shifts the aggregatedemand curve to the right
8/12/2019 MONETARY THEORY.pdf
17/34
8/12/2019 MONETARY THEORY.pdf
18/34
Zero Lower Bound
2008 version of the liquidity trap Nominal interest rate cannot be lowered below zero Even then, aggregate demand may be too low Conventional monetary policy becomes ineffective Need for unconventional measures
Quantitative easing Central Bank purchases of assets from the private sector
(not only government bonds, but equities, securitisedmortgages, etc) Intervention in foreign exchange markets
8/12/2019 MONETARY THEORY.pdf
19/34
Liquidity Trap
8/12/2019 MONETARY THEORY.pdf
20/34
Monetarism Doctrine that money may have powerful
short-term effects on output, but in thelong-run only causes inflation
Economy adjusts to full employmentquite quickly -- prices not very sticky
Inflation is always and everywhere amonetary phenomenon (Milton
Friedman) The money supply affects the economy
with long and variable lags. (Milton
Friedman again)
8/12/2019 MONETARY THEORY.pdf
21/34
Quantity theory of money
demandMV = PY
with velocity fixed Identity becomes a Theory Y fixed -- economy at full employment V fixed If M goes up, then P has to go up
8/12/2019 MONETARY THEORY.pdf
22/34
8/12/2019 MONETARY THEORY.pdf
23/34
8/12/2019 MONETARY THEORY.pdf
24/34
Other channels of influence of
monetary policy Credit availability
banks ration credit (imperfect information /
adverse selection/ moral hazard) demand for credit at existing interest rates
is not satisfied
if more reserves are made available banksmay relax credit limits without loweringinterest rates
8/12/2019 MONETARY THEORY.pdf
25/34
8/12/2019 MONETARY THEORY.pdf
26/34
Portfolio effects
Increase in money supply causespeople to attempt to invest in more
stocks and bonds. This raises share prices and bond
prices
Firms are better able to raise money onstock market and carry out newinvestment projects
8/12/2019 MONETARY THEORY.pdf
27/34
8/12/2019 MONETARY THEORY.pdf
28/34
Money and Exchange Rate
Open Economy trade and capital flows
Floating Exchange Rate
exchange rate determined by capital flows asset price (relative price of two kinds of
assets)
determined largely by expected futurevalue volatile not determined by trade flows in the short
term
8/12/2019 MONETARY THEORY.pdf
29/34
Exchange Rate
Higher money supply -- lower interestrate
lower interest rate inducesfirms/households/foreign residents toinvest in other countries
capital outflow increased supply of / reduced demand
for pounds on foreign exchange market depreciation of the currency
8/12/2019 MONETARY THEORY.pdf
30/34
8/12/2019 MONETARY THEORY.pdf
31/34
8/12/2019 MONETARY THEORY.pdf
32/34
8/12/2019 MONETARY THEORY.pdf
33/34
8/12/2019 MONETARY THEORY.pdf
34/34
Current monetary policy
INDONESIA
?????