3 video 2 slides Money demand models Flashcards
We don’t need to know derivation of the equations, just intuition and interpretation!!!
Slide 3 I should understand the intuition, not derivation
Cagan model intuition? 5.5 Intuition, not derivation
-Current price level depends on future money growth discounted at a factor eta/1+eta, where eta= Anticipated Future Money Growth.
-Change in (expected) future money supply changes prices now.
-Intuition: Future inflation influences money demand now
To make people hold more money if you expect future inflation -> you have to increase nominal rates today. To make them hold that money
Nominal rates?
These rates represent the actual percentage increase in the value of an investment or the cost of borrowing, but they do not account for changes in the purchasing power of money due to inflation.
In the context of borrowing and lending, the nominal interest rate is the rate that is stated on a loan agreement or an investment. For example, if you have a savings account with a nominal interest rate of 5%, it means that your money will grow by 5% over the specified period, irrespective of changes in the overall price level (inflation
Time series main ideas? (he talks so much about this)
What is seignorage? 5.7 was an exam question last year. And what is that equation? (simple) What is problem of Seignorage?
Seignorage represents the real revenue a government (or central bank) acquires by issuing (printing) new money
Seignorage = Mt+1-Mt / Pt
Money increase between 2 periods, divided by price level, because this is in real terms.
The seignorage income is very small
Can a government commit to a constant growth rate for the money supply?
Temptation to create more money in crisis to devalue its debt (large gains from devaluing government debt through inflation = debt deflation)
Independent CB can solve commitment problem?
!!!!!!! Problem with seignorage, besides that government is financed by central bank. -> it is optimal in every period in a static environment to finance the government every period by creating money, because government is happy, the public is happy as well (because public services are provided), but if you will do the same every period, it leads to suboptimal outcomes in the long run, because it generates inflation in the long term. (That’s the link with the quantitative theory of money where inflation in the long term is always is always monetary, so it comes from excessive money creation.)
(For governments inflation is not that bad, because it reduced the amount of debt they have)
Redenomination?
Redenomination refers to the process of adjusting the nominal value of a country’s currency, usually by introducing a new unit of currency or by changing the value of the existing currency. This is different from a devaluation or revaluation, as redenomination does not alter the actual value of the currency in terms of its purchasing power or exchange rate.
Redenomination does not impact the real value of money. If, for example, 1,000 units of the old currency are redenominated to 1 unit of the new currency, the actual value of what the currency can buy remains the same.
Money demand?
Money demand refers to the desire of individuals, businesses, and institutions within an economy to hold a certain amount of money. It represents the quantity of money that people choose to keep in the form of cash or in easily accessible accounts
Money demand is ____ related to inflation
inversely
Interest Rates and Returns: When interest rates are high, the potential returns from interest-bearing assets are also high. In this scenario, the opportunity cost of holding money (which earns little to no interest) becomes more significant. As a result, people are more inclined to invest in interest-bearing assets to maximize their returns.
Conversely, When Interest Rates are Low: When interest rates are low, the opportunity cost of holding money is reduced. In this situation, individuals may find it less attractive to invest in interest-bearing assets because the returns are not significantly higher than what they would earn by holding onto money. Therefore, the demand for money tends to be higher when interest rates are low.
What is purchasing power parity (PPP)? This concept is repeated again
Uncovered interest rate? (UIP) 5.9
The uncovered interest rate parity (UIP) is an economic theory that describes the relationship between exchange rates and interest rates. Specifically, uncovered interest rate parity suggests that the expected return on an investment in a foreign currency should equal the interest rate differential between two countries.
Here are the key points related to uncovered interest rate parity:
Expected Return: According to UIP, the expected return on an investment denominated in a foreign currency is equal to the interest rate on that currency plus the expected rate of appreciation of that currency.
Interest Rate Differential: The interest rate differential is the difference between the interest rates in two countries. If the interest rate in Country A is higher than in Country B, investors might expect a higher return by investing in assets denominated in the currency of Country A.
Exchange Rate Expectations: UIP takes into account the expected change in the exchange rate between two currencies. If investors expect the currency of the higher-interest-rate country to appreciate, the total expected return on the investment in that currency may be higher, despite the lower interest rate.
What does exchange rate depends on (expectation of?) 4 things 5.10
Exchange rate depends on:
- Path of future nominal money supply at home
- Path of future home output
- Path of future foreign nominal interest rates
- Path of future foreign price level
Expected exchange rate change (now) is determined by the future path of money supply changes.
-Stable money supply process can help to reduce exchange rate volatility
Model shortcomings:
-Exchange rate only related to (foreign output)
-PPP assumption problematic
-No role of capital flows and wealth allocation
-No intertemporal budget constraints for either individuals or government
Money demand is determined by?
Money demand is determined by transaction needs in cash. Money demand is tied to next period consumption
