Chapter 19 Flashcards
Quantity theory of money assumption
interest rates have no effect on the demand for money
velocity of money
rate by which each dollar changes hands per year (avg number of transactions dollar is involved in)
Velocity equation
V = (P x Y) / M
V
velocity
P
price level
Y
aggregate income (output)
P x Y
aggregate nominal income
Equation of exchange
M x V = P x Y
velocity is _____ over the short term
constant
k
= 1 / v
what impacts velocity slowly over the long term
institutional and technological features
Equation for money demanded
Md = k x PY
at equilibrium, Md = M
Why is demand for money not affected by interest rates according to quantity theory of money?
at equilibrium, money demanded is money supply
Therefore, Md = k x PY, and money demanded is impacted by velocity (constant) and aggregate nominal income
How does change in quantity of money impact price level according to quantity theory of money
Change in quantity of money leads to proportional change in price level.
inflation formula given quantity theory
inflation = % change M - % change Y
3 options for gov to pay bills (debts)
raise revenue by levying taxes
go into debt by issuing bonds
create money and use it to pay for spending
Since U.S. can’t print money to pay its debts, what is the alternative?
issue new currency and engage in open markey purchase to boost Monetary base and money supply
Modern Monetary Theory
The government could pay for a large bill by buying bonds from the public to increase money supply
But this increased money supply can bring very high inflation
why do people hold money according to Keyne’s liquidity preference theory?
transactions, precautionary, speculative
speculative motive in detail
opportunity cost of holding money is interest on other assets (bonds), so as i increases, people hold less money
therefore, interest rates impact money demanded
Liquidity preference function
Money demanded is negatively related to i and positively related to Y
Velocity movement according to liquidity preference theory
velocity is not constant, movement of interest rates should induce procyclical movements of velocity
theory of portfolio choice and keynesian liquidity preference
demand for real money balances is positively related to income and negatively related to the nominal interest rate.
other factors that impact demand for money
wealth, risk, liquidity of other assets
how does an increase in interest rates impact money demanded
decrease
how does an increase in income impact money demanded
increase
how does an increase in payment technology impact money demanded
decrease
how does an increase in wealth impact money demanded
increase
how does an increase in riskiness of other assets impact money demanded
increase
how does an increase in inflation risk impact money demanded
decrease, money is more risky so its less desireable
classical quantity theory summed up
velocity is constant (predictable)
aggregate spending is determined by quantity of money
keynesian theory summed up
more sensitive to interest rates the higher the demand for money
more predictable velocity, less clear link between M and Y
liquidity trap
an extreme case of ultrasensitivity of demand for money to interest rates when money demand is flat (perfectly elastic) –> conventional monetary policy has no effect on i and Y
actual impact of interest rates on money demand
As long as nominal interest rates do not hit the zero lower bound, empirical data shows evidence of sensitivity of demand for money to interest rate
