Ch 3 - The demand for money Flashcards
Why do we need money?
To solve the double coincidence o f wants problem associated with barter and to avoid the lack of trust between the payer and the payee in a transaction
Name 4 determinants for money demand at the individual level
interest differentials, cost of transfers, price uncertainty of assets and the expected pattern of expenditure and receipts
What are the 3 motives for money demand as per Keynes?
Transaction, precautionary and speculative motives
State 2 shortcomings of Keynes’ liquidity preference model
Interest rates are sticky, differences of opinion on the interest rate
Avg money demand is a positive function of _________ and ______. It is also a negative function of _________
Transaction costs, income/exp, int rate earned on alternative assets
State 2 disadvantages of the Baumol- Tobin model
Assumes that the pattern of expenditure and receipts is known, does not correspond with empirical evidence
Describe Keynes’ liquidity preference model
This model assumes that individuals hold their expectations of interest rate movements with certainty and thus, people will hold either as little cash as possible or everything as cash
What is the Tobin portfolio selection model?
To overcome the problem presented in the Keynes’ liquidity preference model, Tobin considered the problem of how much money to hold as one where individuals maximize utility by choosing between assets in a portfolio
The vertical LM curve represents the _____
Classical case
The horizontal LM represents the _______
Liquidity trap
Why do money demand functions break down?
Greater financial innovation, oil shocks, misspecified model, structural breakdown, overly simplified economics, financial system is subject to rapid change
Typically, the transactions and precautionary motives are _______ volatile than the speculative motive
Less
`In the Keynes liquidity preference model, individual’s demand for money as a function of int rate is a _______ function
Step
In the Keynes liquidity preference model, if the actual int rate is _____ than the expected int rate, individuals put all their financial wealth in the form of money to avoid capital losses associated with holding bonds
Less
In the Keynes liquidity preference model, if the actual int rate is _____ than the expected int rate, expected int rate would be associated with a capital gain from holding bonds, Thus the individual would hold as little money as possible
Greater
What is the plunger problem?
As individuals hold expectations of int rate with certainty, they either hold no money and all long term bonds, or held all money and no bonds. Individuals were plungers-all or nothing
The Baumol Tobin model, models the _______ demand for money
Transactions
What is the objective in the Baumol Tobin model?
Choose the optimal amount of money to withdraw on each bank visit in order to minimize the cost of holding money
As per the Baumol Tobin model, interest and income elasticities are ______ and ___________ respectively
-1/2 , 1/2
Why do bonds carry a positive risk/ variance?
Due the possibility of capital gains or losses if the bond is sold before maturity
In the Tobin portfolio selection model, the individual’s objective is to _______
Determine the optimal weight to be placed in money and bonds
What do you mean by ‘money is homogenous of degree 1’?
If the price level doubles, the demand for nominal money balances doubles
