Week 3 Money, banking, prices and monetary policy Flashcards
Does money directly yield utility?
No, it is merely a “veil” which enables the purchase of items which do.
How does money play a role in our economic activity?
By facilitating exchange.
Give 3 features of a simple monetary model
- Time is discrete and we have an infinite number of periods (t = 1, 2, . . . , ∞)
- In each period (bar the first one) there are two generations of agents: young and old, each of size N.
- Agents live for two periods (young and old) and they are all identical within their group
In a simple monetary model, what is 1 key feature about the total population size?
It remains constant.
In a simple monetary model, what is the total population size?
2N
Give 6 assumptions a simple monetary model
- Agents value leisure when young and consumption when old
- The initial old are endowed with an initial money supply M (so M/N per old) euros
- The initial old value consumption (but not money) so they would like to trade M/N for goods, but with whom?
- The young are not endowed with money but can produce output via y = z(1 − l) but they only value l; they will value consumption when old
- Can summarise this as u(l, c)
- The output is non-storable
So what do young agents value In a simple monetary model?
Leisure, until they are old, when they will value consumption
In a simple monetary model, what does the output being non-storable mean?
A young person cannot produce something, and store it until they are old and consume it then.
In a simple monetary model, if the price of output (in euros) is pt, what does a higher price mean?
Money has less purchasing power.
In a simple monetary model, if agents are going to accept money as medium of exchange, what must be true?
If agents are going to accept money as medium of exchange, it must have value: pt < ∞ (ie money isn’t worthless) ∀t
In a simple monetary model what is the production function for the representative young agent?
y = z(1-L)
In a simple monetary model, as the young person doesn’t value their output, what is the best they can do?
Sell it to the current old for money.
In a simple monetary model, if price of good in euros is pt, what does a young person budget constraint ( mt)=?
mt = ptz(1 − l)
In a simple monetary model, as people only purchase goods when they’re elderly, what is an old person’s budget constraint?
mt= pt+1 *c
In a simple monetary model, by combining the 2 constraints, we get the agents lifetime budget constraint for a given p. What is this?
c =(pt/pt+1)*z(1 − l)
What does Πt+1 stand for?
The inflation rate
In stationary equilibria, what do we have for variables that (may) grow?
Constant growth rates
When (l,c) is chosen to maximise u(l,c), what is this subject to?
c=Π^−1*z(1 − l)
Draw The Demand for Real Money Balances graph.
Check notes for answer
What is the demand for nominal money balances equation?
mtD = ptz(1-ld)
What is the demand for real money balances equation?
(mD/pt) = z(1-lD)
What does Π stand for?
The expected rate of inflation
If (mDt/pt) = z(1-lD), why does qD = z(1-lD),
As qt is identical to mt/pt
What does qD = qD(z,Π) imply?
Demand for real money balances only depends on technology and the expected rate of inflation
What are the effects of an increase in Π?
- The horizontal intercept is unchanged: if you do not work, you do not consume
- But receiving M today will purchase less in the next period so the BC becomes flatter
- As the slope changes, we therefore have IE and SE
- qD will also be affected (assume SE > IE) so qD falls
What are the effects of an increase in z?
An increase in z is exactly the opposite of our results above, except that there is also a direct effect of z on qD.
What are the real world interpretations of an increase in Π?
- An increase in expected inflation causes a movement away from activities that rely on cash towards non-cash sectors
- An increase in expected inflation causes a movement towards non-market activities
What is monetary demand given by?
The demand is given by qD(z, Π) (real) per young, NqD(z, Π) in total.
What is monetary supply given by?
The supply is M/pt (held by the old)
So therefore what is the equation for money market equilibrium?
M/pt= NqD(z, Π)
This must hold every period, including t + 1
If inflation is 5%, what is Πt? What if its 0%?
5% Π=0.05
0% Π=1
If pt+1 = pt, what does that imply about Π?
That Π=1, as the price level is remaining constant.
What is significant about this equation describing the initial old’s consumption: c0*=M/Np1=qD(z, 1)?
The initial old’s consumption is determined by the amount of output the young are willing to produce in exchange for money, qD(z, 1)
What does each young agent therefore work and what do they produce?
- Each young agent works n∗ = 1 − lD(z, 1)
- Producing y∗ = zn∗
- This is exchanged for q∗:
- c∗ = y∗ = q∗ = qD(z, 1)
What is the role of money in this simple model?
If money didn’t exist in this model, young people wouldn’t be able to trade with the old, so l would =1 and C would = 0
Is welfare higher under autarchy or in the monetary equilibrium?
The Monetary Equilibrium
Why can’t we have trade between young and old in the overlapping generations model?
As the old will not be there to fulfil their promises
Will a change in the quantity of money have any real effects?
No, all real variables will remain unaffected as a 1 off increase in M won’t effect anything real and only nominal values:
pt+1M/ptM = NqD(Z,Π)/NqD(Z,Π)
Does a growth in the money supply cause a change in any real variables?
No as Π∗ = µ
What would doubling µ do?
Double the inflation rate
