money demand pres
TRANSCRIPT
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MONEY DEMANDAND SUPPLY
FUNCTIONS
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DEMAND FOR MONEY
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(a) Transaction Motive:
Keynes agreed with the classical theory that money is used as a medium ofexchange. So peoples demand for money is for the purpose of transactions and as
income rises, people have more transactions and people will hold more money.
(b) Precautionary Motive:In addition to holding money to carry out current transactions, Keynes observed
people hold money to be used in future for unexpected needs and emergencies.
Since this also depends on the amount of transactions people expect to make,money demand is again expected to rise with income.
(c) Speculative Motive:Keynes suggested that people also hold money as a store of wealth.
Because wealth is tied closely to income, the speculative motive for money
demand is related to income.
Keynes assumed that people stored wealth with either money or bonds. When
interest rates are high, rate would then be expected to fall and bond prices would
be expected to rise. So bonds are more attractive than money when interest rates
are high. When interest rates are low, they then would be expected to rise in the
future and thus bond prices would be expected to fall. So money is more attractive
than bonds when interest rates are low. So under the speculative motive, money
demand is negatively related to the interest rate
People hold money for three reason
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Determinants of Money Demand
DeterminantsofMoney Demand
Income Wealth Interest rate
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INCOME
MONEY IS NEEDED TO CARRY OUT TRANSACTIONS AND THE VALUE OF
THE TRANSACTIONS A PERSON WOULD HAVE OBVIOUSLY VARIES
DIRECTLY WITH HIS/ HER INCOME.
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Fishers equation: MV=PT
Cambridge equation: M=k PYWhere
M=money supply
V=velocity of circulation of money
P=general price
T=volume of transaction(=real income)
k=proportion of nominal income held in
money
y=output (real income)
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Money Demand
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Wealth
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WEALTH
James Tobin and Milton friedman
(1956) have imparted money
demanded a portfolio theory
approach.
The more wealth a person has,
the more he/she would save, andthe larger would be the size of
his/her portfolio.
Thus, wealth is a positive factor in
the money demand function.
However, since income includes
the income from wealth, it is often
taken as a surrogate measure ofthe asset holding power of
individual.
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INTEREST RATE
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Money Demand
1i
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BP=I/1 + i +I/(1+i)2 +I/(1+i)3 +..
Where BP=bond price
I=interest on bond each period
i=interest rate in the market
BP= I/i
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N1
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MONEY DEMAND FUNCTION
L/p = F(y, ,Pe)
F1>0>f1,f3
Where L=money(l quidity) demand in nominalterms
P=price level
Y=real income
i=interest rate (nominal)Pe=expected inflation rate
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SUPPLY OF MONEY
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Sources of Broad Money Supply in
India
Supply of money
CurrencyMultiple Creation
of Deposits
Money supply
functionBank deposits
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Source 1990-91 2000-01 2002-03
1. Net bank credit to government
y RBIs
y Other banks
2. Bank credit to commercial sectory RBIs
y Other banks
3. Net foreign assets of banking sector
y RBIs
y Other banks
4. Government currency liabilities to public
5. banking sectors net monetary liabilitiesother than demand & time deposits
y RBIs
y Other banks
6. Broad money (M3) (1+2+3+4-5)
1402
888
514
171863
1655
106
80
26
16
583
270
313
2658
5120
1539
3581
6792133
6659
2498
1972
526
54
1331
793
538
13,132
6781
1027
5574
906630
9036
3937
3582
355
71
2602
1271
1331
17,252
Sources of Broad Money Supply in
India
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CURRENCY
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BANK DEPOSITS
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MULTIPLE CREATION OF
DEPOSITS
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MONEY SUPPLY FUNCTION
M= C + D
H= C + R
Where M= money supply
C= currency with public
D= bank deposits
H= high-powered money
R= bank reserves
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Components of Reserve Money
component 1990-91 2000-01 2002-03
1. Currency in circulation
yWith public
yWith banks
2. Other deposits with RBI3. Bankers' deposits with RBI
4. Reserve money(1+2+3)
553
531
22
7
318
878
2182
2095
87
36
815
3033
2825
2710
115
32
836
3691
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Money Multipliers
tem At the end of financial year
1970-71 1980-81 1990-91 2002-03
1. Narrow money supply(M1)
2
.B
road moneys
upply (M3
3. High powered money (H)
4. Narrow money multiplier (1/3)
5. Broad money multiplier (2/3)
74
11048
1.54
2.29
234
558195
1.20
2.86
929
26
58878
1.06
3.03
4728
17
.7
52
3691
1.28
4.67
Note: this is net of the proceeds from the Resurgent Bonds (Rs.256.62
billion), which are deposited with the state Bank Of India since August
28, 1998.
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Sources of Reserve Bank
Source 1990-91 2000-01 2002-03
1. RBIs claims on
y Government
yCommercial & cooperative banks
yNational bank for agri. & rural dev.yCommercial sector
2. Net foreign assets ofRBI
3. Govt. currency liabilities to public
4. Net non-monitory liabilities of the RBI
5. Reserve money (1+2+3+4)
888
69
3163
80
16
270
878
1539
64
66
133
1972
54
793
3033
1207
14
5830
3582
71
1271
3691
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REGULATION OF MONEY SUPPLY AND
INSTRUMENTS OF MONETORY POLICY
InstrumentsofMonetary Policy
Open Market
Operation
Selectivecredit
control
Moral
persuasionBank rate
Cash reserve
ratio
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OPEN MARKET OPERATION
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CASH RESERVE RATIO
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BANK RATE
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SELECTIVE CREDIT CONTROLS
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MORAL PERSUASION
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