Money markets Flashcards
Name two characteristics of fiat money
- intrinsically useless
2. unbacked
State the primitives of the money-markets section
Consumption as young: P(t) * C(yt) Consumption as old: P(t+1) * C(ot+1) Nominal bonds: b(t) Nominal interest rate: 1+R Price period t: P(t) Nominal wage period t: W(t) Change in money supply: µ Change in money supply: π
State the “household’s maximization problem” budget constraints in the first period
P(t) * C(yt) + b(t+1) = W(t)
State the “household’s maximization problem” budget constraints in the second period
P(t+1) * C(ot+1) = (1+R) * b(t+1)
What constitutes the slope in the diagram with C(yt) and C(ot+1)?
-(1+r) i.e. negative real interest rate
Explain why the slope in the diagram with C(yt) and C(ot+1) gets steeper as real interest rate increases
Because the higher the interest rate, the more disproportionate the trade-off between consuming now and consuming later. The steeper slope indicates that more utility can be extracted by waiting, letting the money grow, and consuming when you are old.
What is the basic formula for the quantity theory of money?
M / P = (1 / V) * Y
i.e. real money supply = real money demand
State the formula defining velocity of money
M * V = P * Y
State the approximate formula for nominal interest rate
R ≈r + π
When does Fischer’s approximate formula not work?
When levels of inflation are very high
Explain the trade-off between transaction costs and interest foregone
High interest –> it’s good to have money in the bank –> you make many small withdrawals (instead of one big one –> high transaction costs (but interest revenue intact)
Why does demand for real money decrease as interest rates increase?
High interest –> it’s good to have money in the bank (as opposed to having cash i.e. real money)
State the two definitions of real money demand
Φ(Y,R) = (1 / V) * Y
State the formula for opportunity cost of saving / not saving, in both real and nominal terms
Opportunity cost = return on alternative – return on money
Nominal: R(t) – 0 = R(t)
Real: r(t) – (–π(t)) = R(t)
How do you know there is a money-market equilibrium?
M(t) / P(t) = Φ(Y,r + expected π(t))
Name two assumptions of the money-markets section
- The future is non-stochastic
2. Agents forecast perfectly
State the formula for the present value of budget constraints
P(t) * c(yt) + (P(t+1) * c(ot+1)) / (1+ R) = W(t)
State the formula (using nominal interest rate) for real interest rate
(1+R) / (1+π)
Define velocity of money
Velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period
What are the aims of citizens and firms, respectively, in the market economy?
Citizens maximize utility, firms maximize profits
State Fischer’s theory of interest rates and inflation
R = r + π(e)
According to the Baumol-Tobin money model, what is an individual’s real money demand in response to increased interest rate?
- economize on money holdings (more frequent but smaller withdrawals)
- lower average real money holdings
State the equilibrium condition of the Baumol-Tobin money model
Φ(Y,R) = M / P
What is the nominal return on money in the Baumol-Tobin money model?
Zero
What is the real return on money in the Baumol-Tobin money model?
-π(t) / (1 + π(t)) ≈ -π(t)
