3 Flashcards
whats is the name that groups the most narrow definition of money and what are the different groups of assets that compose it
Currency in circulation, checking deposits, and debit card accounts for the most narrow definition of money (M1)
are currency deposits included or excluded from M1?
they are excluded from M1 although they may act as a substitute for money in a broader definition
what is the money supply?
the qty of money that circulates in the economy
who controls the money supply?
central banks
what is the money demand?
the money demand represents the amount of monetary assets that people are willing to hold (instead of more illiquid assets)
what are the factors affecting individuals’ money demand?
- expected rates of return on non-monetary assets (opportunity cost)
- inflation risk
- liquidity
how does the expected rates of return on non-monetary assets affect individuals money demand?
higher expected returns on non-monetary assets imply a higher opportunity cost = lower money demand
how does the inflation risk affect individuals money demand?
unexpected inflation reduces the purchasing power of money, but many non-monetary assets are subject to inflation risk = it is not very important in defining the demand of monetary assets vs non-monetary assets
how does liquidity affect individuals money demand?
individual’s money demand increases when the price or qty of purchased goods increase
what are the factors affecting aggregate money demand?
- expected rates of return on non-monetary assets
- prices of goods and services
- aggregate real income
how does the price of G&S affect aggregate money demand?
higher average prices mean a greater need for liquidity to buy the same amount of G&S = higher demand of money
how does aggregate real income (Y) affect aggregate money demand
higher Y means more G&S produced and bought = higher need for liquidity = higher money demand
what is the aggregate money demand fct?
Md = P * L(Y,R)
what is the aggregate real money demand fct?
Md/P = L(Y,R)
what is the relationship between R (interest rate) and aggregate real money demand for a given price lvl and GDP?
it is a downward sloping curve as Md increases as the interest rate decreases: opportunity cost of holding money is low when R is low
what happens to aggregate real Md when there is a rise in real income (Y)?
when Y goes up for a given interest rate, demand for money goes up = shift of the downward sloping curve to the right
what defines the money market equilibrium?
the money market is in equilibrium when no shortages (excess demand) or surpluses (excess supply) of monetary assets exist: Ms=Md
when is the money market in equilibrium?
when the qty of real monetary assets supplied matches the qty of real monetary assets demanded: Ms/P = L(Y,R)
what happens when R increases and how does the money market goes back to equilibrium?
when R increases, there is an excess supply of real money relative to the demand of real money because people want assets instead of money because there is a larger opportunity cost of holding cash. more demand for assets = asset prices appreciates = R decreases back to equilibrium where Md=Ms
what happens when R decreases and how does the money market goes back to equilibrium?
when R decreases, real money demand is greater than real money supply (excess demand) = low demand for assets = prices decrease = R increases back to equilibrium where Md=Ms
when is the FOREX market in equilibrium?
when interest parity holds
R$ = Reuro + ((Ee-E)/E)
when is the money market in equilibrium?
when real money supply is equal to real money demand
Ms/P = L(Y,R)
what can we say about prices in the short run?
in the SR prices are fixed: prices do not have sufficient time to adjust to changing market conditions (prices are rigid)
what are the reasons for price rigidity in the short run?
- wages (input cost) adjust infrequently: since prices depend on input costs, sticky wages = sticky prices
- menu costs: cost of updating pricing
- customer relationships
what are the consequences of short run price rigidity?
- in the short run, R denotes both the nominal and real interest rate since prices and inflation are fixed
- a change in Ms affects real variables like output, employment, etc.
what is the effect of an increase in the US money supply (expansionary policy)?
the real Ms vertical curve shifts to the right and therefore in equilibrium, R decreases = reduces rate of return on US deposits = dollar depreciates = exchange rate increases which restores interest rates parity and equilibrium
what is the effect of an increase of the euro money supply?
increase in the euro supply = interest rate on euro deposits decrease = IUP condition implies that euro depreciates (US dollar appreciates)
what is the effect of a rise in real income (Y - economic expansion)?
when GDP goes up, there are more transactions of G&S = Md increases = shift of the curve to the right = R increases to adjust equilibrium = US dollar appreciates
what can we say about prices in the long run?
in the long run, prices have sufficient time to adjust to market conditions
what can we say about money in the long run?
money is neutral in the long run : a permanent change in money supply only affects the price lvl
what are the implications of money neutrality?
- real variables, like the real interest rate and real money demand, are not affected by money supply in the long run
- long run output is determined by techno, workers, physical and human capital and natural resources (Y=A * f(K,L,H,N))
considering long run equilibrium and money neutrality, what happens to prices when Ms changes permanently?
in the long run, prices adjust proportionally when Ms changes permanently (Ms = P * L(Y,R))
since real money demand (L(R,Y)) is not affected by changes in Ms, P adjusts one for one
what is the rate of inflation?
it is the change in prices over 2 time periods
inf. rate = (P2-P1)/P1
what does the money market equilibrium implies when it comes to the inflation rate?
it implies that the inflation rate is equal to the growth rate in money supply minus the growth rate in real money demand
