Money (+intro SR)

Question 1

Functions of money?

Answer 1

Medium of exchange
Unit of account
Store of value
Liquidity

Question 2

What’s the equation of the money supply? Are debit cards and cheques money supply?

Answer 2

M = C + D

Currency, which is outstanding paper money and coins

Deposits, which are balances in bank accounts depositors can access on demand

No they aren’t! They’re simply a means of transferring money between accounts, they have no impact on the money supply

Question 3

DEF: reserves

Answer 3

Deposit that banks have received

But haven’t lent out

Question 4

Is money created under 100% reserve banking? What about fractional reserve banking?

What’s the total money supply’s relation with the reserve deposit ratio and the original deposit?

Answer 4

No, because just transferred from one form eg C into another eg D

Yes, because as prop kept in reserves, the rest lent out, injecting more money into the system. New money BUT ALSO equal amount of new debt.

Total money supply= 1/rr x original deposit

Question 5

How is bank capital related to leverage?

What’s the leverage ratio and why does it being high imply bad news?

Answer 5

Bank capital is equity of bank owners. Leverage is the use of borrowed funds to supplement existing funds for purposes of investment.

Leverage ratio
= (assets or liabilities) / bank capital

If value assets fall by x%, debt holders and depositors have to be paid first, so the value of owner’s equity falls. If assets

Question 6

Solution if high leverage ratio?

Answer 6

Capital requirements! Minimum amount of capital mandated by regulators, to ensure banks will be able to pay off depositors

Question 7

Model of money supply
What are the three assumed exogenous variables?
How do we find M given we know the money supply equation and the money base equation?

Answer 7

1) Monetary base
2) Reserve deposit ratio, rr
3) Currency deposit ratio, cr

Base given by B = C + R
Money supply M = C + D

So… M/B = (C+D)/(C+R) = (cr+1)/(cr + rr)

So M = (cr+1)B/(cr + rr)

(cr+1)/(cr + rr) is the money multiplier, happens when rr<1

Question 8

How does CB manage monetary base?

Answer 8

1) Refinancing rate - rate at which CB willing to lend to bank SR. Buys assets of bank which agrees to buy back at agreed price.
2) OMO (outright) - buying/selling bonds from public in bond market (usually government securities)
3) Reserve requirements - rr set, influences money multiplier
4) Interest on excess reserves - current accounts for banks in CB to hold their excess reserves

Question 9

Quantity equation? Explain it

Answer 9

MV = PY

money times the amount it’s changing hands (velocity of circulation) is price times output, which is the value of total output.

This comes from proxy of T because as production rises number of transactions would rise. Stems from V = T/M

Question 10

Using growth rate rules, what can we predict from the QTM?

Answer 10

MV=PY

Pi = g.m - g.y

We need some money growth to facilitate the increased need for transactions, but any growth beyond that results in inflation.

There’s a one-for-one relation between changes in money growth and changes in the inflation rate

Question 11

What would money depend on? What is so special about the inflation rate when we sub in i with Fisher eqn?

Answer 11

L(i,Y)

i is the opp cost of holding money, the higher it is the less demand for money we have

Y is income - higher Y, more spending so need more money

The fisher eqn is speshal cuz we have ex ante real interest rate involved, and so nominal is
i= r+pi^e

EXPECTED INFLATION, people don’t know what inflation will be when they wanna hold money or bonds

Question 12

What happens if you change expected inflation?

Answer 12

Increase inflation expectations, i rises via Fisher, this lowers money demand, which increases prices to make real money balances re-establish equilibrium

Question 13

What mappers if you change the money supply?

Answer 13

Channel 1:

QTM: we have a rise in money supply, which increases prices one for one

Channel 2:

QTM and Fisher: because we have this increase in money supply, there is a rise in inflation expectations, which increases the nominal interest rate, which reduces real money demand and so prices must rise to equilibrate this

Question 14

Costs of expected inflation

Answer 14

1. Menu costs
2. Shoeleather costs
3. General inconvenience
4. Relative price distortions
5. Unfair tax treatment

Question 15

Costs of unexpected inflation?

Answer 15

Distributional consequences, arbitrary, pensioners might be affected

Uncertainty can affect inter-temporal decisions, people are risk averse

Question 16

What’s the ONE benefit of inflation?

Answer 16

Allows markets to adjust… nominal wages rarely go down, so can keep those constant and as inflation rises real wages fall and this may help Wr reach LR equilibrium

Question 17

DEF: seigniorage

What’s the government spending equation?

Answer 17

Revenue the government obtains from printing more money (change in M)

G = T + change in B + change in money supply

Printing more money to finance it’s spending, but this may be considered an inflation tax as it shows by the rise in prices, it’s paid by people holding currency (every other asset is protected due to i rising)

BUT delays in taxation, this falls so real taxes fall, kinda a spiral

Question 18

DEF : classical dichotomy

Answer 18

The separation of real and nominal variables, nominal has no effect on real

Question 19

Neutrality of money

Answer 19

Any changes in M DON’T affect real variables

Question 20

DEF: detrended output

What’s its relationship between actual (Y), potential (Y bar), and the cyclical/short-run fluctuations component?

Answer 20

Detrended output is the difference between actual and potential output, expressed as a percentage of potential output

Question 21

What is Okun’s Law?

Answer 21

u - ū = -1/2 x Ŷ (ST/detrended output)

For every percentage point that actual output is below potential, the unemployment rate exceeds the natural rate by half a percentage point