Money, prices and Inflation. Flashcards
What features define money
- currency
- bank deposits that can be accessed quickly to make transactions I.e debit cards
What types of money are there ?
-m0&m1: coins and notes
-m2: m1 plus non transaction deposits that can quickly be converted into money
M3: m2 plus funds that can be quickly accessed in the money market
Show that money supply is a function of monetary base and behavioural parameters c and k
M= money supply D= bank deposits B= monetary base Ch= money held by households cD= currency held by households as a function of their bank deposits kD= Bank reserve
M=Ch+D Ch=cD Monetary base is the total currency in the system which is money held by banks and households B= cD+kD B=(c+k)D D=B/(c+k) So M=cD+D M=(1+c)D=(1+c)[B/(c+k)]
How do banks create money ?
Through fractional reserve banking
How can policy makers increase money supply?
By increasing monetary base, c and k are behavioural parameters and cannot be influenced.
Remember M=(1+c)B/(c+k)
How does the open market operations change the monetary base?
The central bank buys and sells government bonds.
When it buys government bonds it gives cash in exchange for bonds which increases monetary base. When it sells bonds it takes cash in exchange for bonds which decreases monetary base.
What can the central bank do to relieve liquidity problems ?
- Lender of the last resort: CB buys assets of bank at a discount so banks have money. They have later buy back their assets at full price.
- Central bank can also sell money which banks purchase with their assets
What are the functions of money ?
- unit of account
- medium of exchange
- store of value
According to the classical theory of money, in the LR what do changes in money supply affect ?
Price levels not output and therefore transactions are fixed
What is the quantity theory of money equation and explain its importance in the LR.
MV=PT
M= money in circulation
V= speed at which money moves
P= price levels
T= transactions
Transactions can be equated to output (may be slightly higher due to second hand and intermediate goods) which is fixed in the LR.
This identifies that the circulation of currency must equate to the monetary value of transactions.
What is the relationship between price levels and money supply in the long run.
MV=PT T=Y=Y* in LR in the long run V is constant so there is a proportional relationship between M and P: M=(T/V)P T/V=¥ M=¥P
How can the quantity theory of money be derived from the demand for money and the money market ?
We start of with the money demand which is dependent on technology and the price of holding money which is the interest rate and this is represented by k. Money demand is also dependent on income Y and price levels P. Md=kPY. We know money demand equilibrium States money demand must equal money supply so: M(money supply)= kPY M(1/k)=PY Where 1/k=v So MV=PY
What is seigniorage?
The cost of the government printing money to fund expenditure. Everyone holding money sees the value of their money fall due to inflation; they can afford less so it’s like they have been taxed.
Why does the fisher equation not match up with real data?
It uses the ex ante formula (expected inflation) rather than ex poste which is what the data is founded on
Other than income what else is money demand dependent on ?
Nominal interest rates as this is the opportunity cost of holding money. If nominal interests rates increase then demand for money decreases which implies when nominal interest rates increase, velocity of money also increases.
