Money, Banking, Prices and Monetary Policy

Question 1

What are the functions of money?

Answer 1

• Medium of Exchange
  
  • Alleviate double coincidence of money
• Store of value
  
  • Trading of current/future goods
• Unit of account
  
  • Prices and contracts denominated in terms of money

Question 2

What is the fisher relationship?

Answer 2

• Fisher relation: r = R - i - ir

- For small values of i and r: r ≈ R - i

Question 3

What is the nominal bond payoff?

Answer 3

(1+R)

Question 4

What is the cost/price in the credit card market?

Answer 4

q

Question 5

What are the elements of credit card demand?

Answer 5

• q: cost
• r: benefit
  
  • cash can be used to earn the market interest rate instead of purchasing because of credit card use
  • Opportunity cost of using currency

Question 6

How is credit card demand derived?

Answer 6

• MB: (1+R)P
• MC (1+q)P
• MB-MC: (R-q)P = (1+R)P - (1-q)P
• Three cases
  
  • MB > MC
    
    • Downward sloping
  • MB = MC
    
    • Flat line at R=q
  • MB

Question 7

What is the effect of an R increase on the credit card market?

Answer 7

• Increase in q because demand is R=q

- Increase in X quantity of credit card services

Question 8

What is money demand?

Answer 8

• MD = PL(Y,r)
• PY = M + P(1+q)X
• MD = PL(Y,R)

Question 9

How is money demand affected?

Answer 9

• P+, Y+, r-, (i-)
  
  • An increase in real income: more currency required as the volume of transactions increases
  • A decrease in the normal interest rate: R is the opporuntity cost of using currency in transactions - higher R implies greater use of credit cards, less currency

Question 10

What is true of the money market relaitve to the credit market?

Answer 10

Money demand locked at the origin - whereas credit supply (SP) shifts fully

Question 11

What is the money demand curve?

Answer 11

UPWARD sloping against P and M

Question 12

How is money supply determined?

Answer 12

MS: perfectly inelastic, set by central bank

Question 13

How can the government increase the money supply?

Answer 13

• Helicopter drop
  
  • Printing more money
  • Reduce taxes without changing other fiscal policy
• Open Market Operation
  
  • Reduce quantity of bonds in the current period by buying them
• Increase G without changing other fiscal policies
  
  • Seignorage revenue aka inflation tax

Question 14

What is the effect of a decrease in the credit card service supply?

Answer 14

• Decrease in X, no change in R

- Shifts money demand out - deflation

Question 15

What is the velocity of money?

Answer 15

• V = PY/M = Y/(M/P) = Y/L(Y,r)
• MV = PY
• V is negatively related to interest rates
• In CIA we assume V is constant

Question 16

What is the fiscal and monetary policy interaction?

Answer 16

• Following -z shock
• Buying bonds
• Active fiscal policy: ↑G
• Passive monetary policy: ↑M to finance G
• B↑ = MS↑
• Combined with the inflationary effect of -z and the ambiguous effect of ↑G, further increases inflation by increasing MS
• Trade off - price level vs output