Topic 4: Keynesian Monetary Theory

Question 1

What is the indirect version of the quantity theory?

Answer 1

Where the interest rate is the price that equilibriates savings with investment demand.

Question 2

How does keynes treat money in comparison to the indirect quantity theory?

Answer 2

Money is treated instead as a liquid asset in a larger portfolio of other financial assets.

Question 3

What are the characteristics of money relevent to the Keynesian view?

Answer 3

1. A high liquidity preimum
2. Negligible or zero elasticity of production
3. Negligible elasticity of substitution

Question 4

What are the three types of return to an asset in the Keynesian view?

Answer 4

Pecuniary return (r_mt): interest on bonds, return on shares, services recieved from capital goods.

Non-Pecuniary return (r_pt): Return for the services provided by liquidity, such as ease and speed of dispsal , certainty of future vlaue, divisibility and security from theft.

Conveniece cost (r_at): The cost of holding assets to acquire pecuniary and non-pecuniary costs.

Question 5

What does Keynes suggest about the various types of returns to assets.

Answer 5

For money, the liquidity premium exceeds it’s carrying cost.

For other assets, their carrying costs exceeds their liquidity premium

Question 6

What is monies elasticity of production?

Answer 6

An increase in demand for money can just be an indication of greater willingness to pay for liquidity and not to invest, and doesn’t necessarily mean an increase in demand for actual goods.

Question 7

What is keynes’s three motives for holding money?

Answer 7

1. Transactions (bridge the interval between receipt of income and expenditure
2. Precautionary motive
3. Speculative motive (Holding cash to manage risk)

Question 8

What is the critical rate? Where speculative demand switches from bonds to full money

Answer 8

0 = r_t + (r_t/r^e_t - 1)

r_ct = r^e/(1+r^e)

Question 9

What’s is the liquidity premium?

Answer 9

Means a willingness to pay a price for the security of money (holding wealth in liquid form) gives.

When the premium is high, the cost of money rises above the marginal efficiency of capital in the real sector and discourages investment.

Question 10

Derive the critical rate in Tobin’s Model.

Answer 10

1. E(RB) = (r + g)B
2. if g (growth in bond price) is negative, then returns to bonds are negative.
3. g_t = p^e_t+1 / p_t - 1
4. p_t ~= 1/r_t as price is discounted future flow.
5. g_t = r_t/r^e_t -1
6. E(RB) = r_t + r_t/r^e_t - 1
7. So r_ct = r^e / (1 + r^e)

Question 11

Graph speculative money demand.

Answer 11

This is the demand for speculators in the aggregate, who all have different expectations.

Along the LM section, interest rates are above the critical value in aggregate, and all spectators hold bonds. along the MN section, some speculators hold bonds. Along NW, nobody holds bonds.

Question 12

What does the LM curve represent?

Answer 12

Equilibrium in the money markets, as determined by the supply and demand for money. i.e. shows combinations of interest rates and output levels that make M_d = M_s.

Question 13

What does the IS curve represent?

Answer 13

Combinations of output and interest rates where the goods markets are in equailibrium. i.e. The level of spending caused by a particular interest rate.