s6m money supply and demand

7/23/2019 S6M Money Supply and Demand

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The Supply and Demand Of Money

MONEY

What is Money? Money is the set of assets in an economy that people

regularly use to buy goods and services from otherpeople.

Money is anything that is generally acceptable by thepeople as a means of payment in the final settlement

of all transactions including debts.

Money supply is the total amount of money available inthe economy

Wealththetotalcollectionofpiecesofpropertythatservetostorevalue (stock)

Incomeflowofearningsperunitoftime (flow)


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The Functions of Money

Anythingthat

satisfies

the

four

important

functionofit,

amediumofexchange

aunitofaccount

astoreofvalue

astandardofdeferredpayment

Moneyisthemostliquidassets.

Liquidityistheeasewithwhichanassetcanbeconvertedintotheeconomysmediumofexchange.

Agoodmediumofexchange Mustbeeasilystandardized Mustbewidelyaccepted Mustbedivisible Mustbeeasytocarry Must

not

deteriorate

quickly

Evolution of Payment System

( Kinds of Money)1.BarterSystemGoodswereexchangedagainstgoods.

2. CommodityMoney: isamoneywhichhasintrinsicvalue.Ex. Salt,grains,feathers,cowryshells,beads,cigarettesandevenfishhookswereusedlikemoney.

3. Representative Money: Money that consists of token coins, other physicaltokens such as certificates and even nonphysical certificates that can be reliablyexchanged for a fixed quantity of commodity in trade such as gold, silver, oil,

bank check etc. It is backed by 100% precious metal.

4.CreditMoney:Anyfuturemonetaryclaimagainstanindividualthatcanbeusedforthepurchaseofgoodsandservices.Ex.IOUs,Bonds,MoneyMarketAccounts,andanyotherformoffinancialinstruments.

5.FiatMoney:isamoneybydeclaration.Itsthevalueofdeterminedbylegalmeans(legaltender)ex.NotesofRBI.Noconsumptionorinvestmentuse

1.Coins:notfullbodiedmoneybuttokenmoney(intrinsicvalue


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Money Supply

Supply of Money:

Total amount of money held by the public in the country for

transaction purpose.

Is generally fixed during a given year.

Who supplies?

a. Reserve Bank of India, : Paper Notes

b. Central Government of India : Coins

b. Commercial and Cooperative

Banks ( Banking System) : Credit

Money Stock:Total Volume of money at a point of time,

Ex.Dec 31, 2013, held by the public in the country for transaction

purposes

Money Supply (Ms): total amount of money available in the economy

during a period of time, Ex.April 1, 2013 31 March 2014, held

by the public in the country for transaction purposes

Supply of Money


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Supply of Money

Measures of Monetary and Liquidity Aggregates

Classification of Sectors

Too little value of the lower denominations

Supply of Money: Dimensions


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How much to Print & MintReplacement needs ( old worn and tear one)

Incremental needs ( Demand for money: GDP growthrate, inflation rate , interest rate etc.)

Reserve Stock Requirement Needs

(CRR, SLR, Gold reserve, Forex reserve)

Assess the stock on daily basis

Uses statistical analysis and long-term forecast

Printing/minting allocated between the presses/mintsand delivery schedule decided in advance

Uses some Statistical models

Supply of Money

Mint

Press

Issue Offices

Chandigarh

New DelhiJaipur

Lucknow

KanpurPatna

Guwahati

AhamadabadCalcutta

Hyderabad

Banglore

Trivandrum

Chennai

MumbaiByculla

Bhuaneshwar

Nagpur

Mysore

Nasik

Dewas Salboni

Noida

Mumbai

Hyderabad

Calcutta

Bhopal

India Cross-movement of Currency

Fresh Notes/Coins fromPress/Mint pass on to thebanks/public only throughRBI offices hence cross-movement

Supply of Money


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Network of Currency Chests RBI has 19 issue offices for currency operations across India

Distribution of notes and coins throughout the country is done throughdesignated bank branches, called chests.

RBI has authorized selected branches of scheduled banks to establishcurrency chest.

Chest is a repository in a commercial bank to store notes and coins onbehalf of the Reserve Bank

Deposit into chest leads to credit of the commercial banks account andwithdrawal is debit

Supply of Money

As of June 30, 2006 there were 4428 currency chests and 4102 small coins depots.As of Dec 31, 2013 there were 4122 currency chests and 3784 small coins depots.

Currency Chest: Role

Meets currency requirement ofpublic.

Exchange facility from onedenomination to another

Payment requirement of the Govt.

Exchange of damaged notes andwithdraws unfit notes

Avoids frequent movement ofcash

Chest branch operates withminimum cash balance (Rs.1,00,000)

Currency Chest :Mechanism

Net deposit /withdrawal of notes

and coins at the chest is reported

on daily basis to parent Issue

Office or else penalty.

Overall deposit or withdrawal

leads to credit or debit of banksaccount in RBI

Net withdrawal from chests means

expansion of currency and

deposits means contraction

Notes in circulation being the

liability of RBI, it adjusts its asset-

liability position centrally for such

expansion or contraction

Supply of Money


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RBIs Empirical Definition & Estimation of

Money Supply

Cash Demand

Deposits

Fixed

Deposits

Post Office

Deposits

Securities

/Bonds

Physical

Assets, land

Buildings, etc.

Certificate

of Deposits

of Banks

More Liquid Less Liquid

Medium of

Exchange

Functions

Store of Value Functions

Narrow Money (M1)Broad Money (M3)

RBI or Empirical Definition of Money: Components


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RBI or Empirical Definition of Money:

M0 (Reserve Money), M1(narrow money), M2, M3(broad money)

Mo =Currency in circulation + Banker's deposit with RBI+ Other deposits with RBI

Other deposits with RBI= (i) deposits of quasi govt and other financial institutions such as Primary Dealers' balances in the

accounts of foreign centrals banks and govts (iii)accounts of IMF, (iv) provident funds, gratuity and guarantee funds of RBI staff.

Primary dealeris a formal designation of a firm as a market makerof government securities


Measures of Monetary and Liquidity Aggregates


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Components of Money Supply (Rupees crore)



A Stylized Decomposition RBIs Balance Sheet(for Reserve Money)

Liabilities Assets

1. Currency in Circulation(of which)

i. Currency with the Public

ii. Cash in hand of Banks

2. Bank Deposits (CRR, SLR)

3. Govt. Deposits: All Govt.

4. Paid-up Capital:

(Ex. shareholders capital)

5. Reserves :

( Ex. contingency + revaluation

reserves out of retained profit)

6. Other Liabilities

(Ex. EPF, NBFIs deposits)

1. Loans and Advances ( of which)

i. Govt: Centre and State

ii. Banks: commercial and cooperative

iii. Commercial Sector ( NABARD,

other FIs)

2. Investment ( of which)

i. Govt. Securities

ii. Foreign Assets(Net)

3. Gold ( Monetary)

4. Other Assets ( land, building etc.)

Total Liabilities (1 to 6) Total Assets (1 to 4)


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Rearrange RBIs Balance Sheet: (for Reserve Money)

Liabilities Assets

1. Monetary Liabilities

(i+ii)

i. Currency with the

public

ii. Bank reserves

2. Non-Monetary

Liabilities (i+ii+iii)

i. Paid-up Capital

ii. Reserves

iii. Govt Deposits

3. Other Liabilities

1. Net Central Bank Credit to Government (i+ii)

i. loans and advances to Govt

ii. Investment in Govt. Securities)

2. Central Bank Credit to Banks

commercial banks at bank rate, repo rate etc.

3. Central Bank Credit to Commercial Sector (OFIs,NABARD) (i+ii)

i. loans and advances to other financial institutions

ii. Investment on securities of commercial sectors

4. Net Foreign Assets of Central Bank (i+ii)i. Investment in Foreign Assets

ii. Gold ( Monetary)

5. Other Assets

Total Liabilities (1+2+3) Total Assets (1+2+3+4+5)

Reserve Money (M0) =1+2+3-4


A Stylized Decomposition of Reserve Money


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1. Net Central Bank Credit to Government (i+ii-iii)

i. loans and advances to Govt

ii. Investment in Govt. Securities

ii.. Govt Deposits with central bank

2. Central Bank Credit to Banks

commercial banks at bank rate, repo rate etc.

3. Central Bank Credit to Commercial Sector (OFIs, NABARD) (i+ii)

i. loans and advances to other financial institutions

ii. Investment on securities of commercial sectors

4. Net Foreign Assets of Central Bank (i+ii)

i. Investment in Foreign Assets

ii. Gold ( Monetary)5. Government's Currencies Liabilities to the Public

i. Rupee Coins and small coins

6. Net Non-Monetary Liabilities of the Central bank (i+ii+iii-iv)

i. Reserves, ii. Paid up reserves, iii. other liabilities , iv. Other assets etc.

Sources of Changes in Reserve(M0) and High Powered (H) Money


High Powered Money=

Reserve Money + Govts Currency

Liabilities to the Public

H=M0+GCL

Reserve Money (M0) =1+2+3+4-6

High Powered Money(H) =1+2+3+4+5-6


Sources of Changes in Reserve Money(M0) (Rupees Billion)

Year

NetRBI

Creditto

Central

Governme

nt

NetRBI

Creditto

State

Governme

nts

RBICredit

to

Commerci

alSector

Net

Foreign

Exchange

Assetsof

theRBI

Governme

nt's

Currency

Liabilities

toPublic

RBI''s

Gross

Claimson

Banks

Net

Non

monetar

y

Liabilitie

sofRBI

ReserveMoney

(M0)

0 1 2 3 4 5 6 7 1+2+3+4+5+67

197071 36.67 3.33 1.32 5.30 3.84 6.42 8.66 48.22

198081 152.78 11.65 17.00 47.75 6.18 12.76 53.60 194.52

199091 867.58 20.90 63.42 79.83 16.21 100.07 270.22 877.79

200001 1465.34 73.43 132.87 1971. 87 53. 54 129.65 793. 74 3 032.95

200910 2115.81 0. 05 13. 28 12319.44 112.70 11. 69 3016.43 11556. 53

201011 3940.35 25.20 21.64 13285.69 127.24 51.59 3683.50 13768.21

201112 5344.13 13.24 39.60 14721.95 134.44 48.47 6038.41 14263.44

201213 5904.99 0.79 30.58 15580.59 153.40 403.54 6925.02 15148.86


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Sources of Changes in Broad Money Supply (M3)

1. NetBankCredittoGovernment(a+b)

a.CentralbankNetCredittoGovt (iii)

i.Centrak bankscreditto Government

ii.Govt Depositswithcentralbank

b. OtherBankscredittoGovernment

2. BankCredittoCommercialSector(a+b)

a.CentralbankCredittoCommercialSector

b.Other

banks

Credit

to

Commercial

Sector

3. NetForeignExchangeAssetsofBankingSector(a+b)

a. Centralbanks NetForeignExchangeAssets

b. Otherbanksnetforeignexchangeassets

4. Government'sCurrenciesLiabilitiestothePublic

a.RupeeCoinsandsmallcoins

5. NetMonetaryLiabilitiesoftheBankingSector(a+b)

a. NetMonetaryLiabilitiesoftheCentralbank

b. NetNonMonetaryliabilitiesofBanks

Ex.(i).Reserves,(ii)Paidupreserves,(iii)otherliabilitiesetc.


Broad Money Supply(M3) =1+2+3+4-5


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Sources of Changes in Broad Money Supply (M3) ( Rupees Billion)


Year 1970-71 1980-81 1990-91 2000-01 2009-10 2010-11 2011-12 2012-13

Net RBI Credit to Central

Government1

36.67 152.78 867.58 1465.34 2115.81 3940.35 5344.13 5904.99

Net RBI Credit to State Governments 23.33 11.65 20.90 73.43 0.05 25.20 13.24 0.79

Other Banks' Investments in

Government Securities3

14.55 92.75 513.45 3580.78 14576.00 15873.41 18359.56 21166.29

Net Bank Credit to Government 4 54.55 257.18 1401.93 5119.55 16691.86 19838.96 23716.94 27072.07

RBI Credit to Commercial Sector 51.32 17.00 63.42 132.87 13.28 21.64 39.60 30.58

Other Banks' Credit to Commercial

Sector6

63.90 349.41 1654.27 6659.32 34900.81 42345.12 49544.85 56616.06

Bank Credit to Commercial Sector 765.22 366.41 1717.69 6792.18 34914.09 42366.76 49584.45 56646.64

Net Foreign Exchange Assets of the

RBI8

5.30 47.75 79.83 1971.87 12319.44 13285.69 14721.95 15580.59

Net Foreign Exchange Assets of Other

Banks9

0.21 -0.45 25.98 526.45 495.20 647.74 715.85 785.99

Net Foreign Exchange Assets of the

Banking Sector10

5.51 47.30 105.81 2498.31 12814.64 13933.43 15437.80 16366.59

Government's Currency Liabilities toPublic

113.84 6.18 16.21 53.54 112.70 127.24 134.44 153.40

Net Non-monetary Liabilities of RBI 128.66 53.60 270.22 793.74 3016.43 3683.50 6038.41 6925.02

Net Non-monetary liabilities of Other

Banks13

10.26 65.74 313.14 537.81 5489.87 7541.73 9186.84 9493.44

Net Non-Monetary Liabilities of

Banking Sector14

18.92 119.34 583.36 1331.55 8506.30 11225.23 15225.25 16418.46

RBI''s Gross Claims on Banks 15 6.42 12.76 100.07 129.65 11.69 51.59 48.47 403.54

Broad Money (M3) 4+7+10+11-14110.20 557.73 2658.28 13132.04 56026.98 65041.16 73648.37 83820.24

Commercial Banks Credit Creation &Money Supply

Credit Creation


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Credit Creation

Credit Creation


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Credit Creation

Credit Creation


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Credit Creation

Credit Creation


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Credit Creation

Credit Creation


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H = C+R+OD ..(1) High Powered Money; where R= RR+ER

M3 = C+D+OD..(2) Broad Money; where D= DD+TD

High Powered (Reserve) Money, Money Multiplierand Money Supply

Credit Creation

R is Total Reserve; R=RR+ER

RR is Required reserve is the reserve which banks are statutorily hold

with RBI. ( Ex. CRR and SLR) .They have no choice about them.

ER is Excess reserve, all reserves in excess of RR is called as excess

reserve which Banks are free to hold them as cash on hand withthemselves or as balances with the RBI

Since OD is small fraction of total money supply. Its excluded here

Credit Creation


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Credit Creation

Where,

C= Currency

D= Deposits

DD= Demand Deposit

TD= Time Deposit

RR= Required Reserve

ER= Excess Reserve

Where,

M (or M3)= Money Supply H( or Mo)= High Powered Money

Cr= Currency to Deposit Ratio

RRr= RR/D = Required Reserve Ratio

ERr=ER/D= Excess Reserve Ratio

m= Money Multiplier

High Powered Money, Money Multiplier and Money Supply

IftherequiredreserveratioisRRr=10percent,currencyincirculation(C)isRs 400billion,checkabledeposits(D)areRs.800billion,andexcessreserves(ER)totalRs.0.8billion,

Whatsthemoneysupply,monetarybaseandmoneymultiplier?

Cr=C/D=400/800=0.5;

ER=0.8=>ERr =ER/D=0.8/800=0.001;

RRr =RR/D=0.1,=>RR=0.1*800=80billion

m=(1+Cr)/Cr+ERr+RRr)=1.5/0.601= 2.49584

MonetaryBase(orH)=C+R=480.80,R=ER+RR

MonetarySupply(M3)=C+D=400+800=Rs1200billion

Cancheck:M=m*H=m*(C+R)=

2.49584*(400+0.8+0.1*800)=Rs.1200billion

Credit Creation: Example-1


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SupposethedesiredcurrencyratioCris40%,thereserverequirementRRris10%andtheexcessreserveratioERris0.5%

Themoneymultiplieris

M=(1+0.4)/(0.1+0.4+0.005)=2.77

AonerupeeincreaseinthemonetarybasewillleadtoaRs.2.77increaseinthemoneysupply

Notethat

if

Cr

=ERr

=0,

then

the

money

multiplier

wouldhavebeen10.

Accountingforcurrencyandexcessreservesisclearlyimportant.


Let Cr = 0.25, ERr = 0.001, and RRr = 0.1.Compute the money multiplier

Ans. m = (1+0.25)/(0.1+0.001+0.25) = 3.56

The RBI decides to increase RRr to 20%. Whathappens to the money multiplier (and the moneysupply as a result?)

Ans.

m = 1.25/0.456 = 2.74

A smaller multiplier means that banks create lessmoney through lending and therefore the moneysupply will fall



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Whathappens

to

the

money

multiplier

when

the

desiredcurrencyratio(Cr)rises?

LetCr=0.2,RRr =0.25,andERr =0.05Thenm=(1+0.2)/(0.25+0.05+0.2)=1.2/0.5=2.4

NowsupposeCrrisesto0.3,whileallothervariablesremainconstant

Thenm=(1+0.3)/(0.25+0.05+0.3)=1.3/0.6=2.17

Increasingthefractionofdepositsheldascurrencycausesthemoneysupplytofall Moneyisbeingtakenoutofthebankingsystemwhereit

couldhavebeenusedtomakeloans.


ChangesinthecurrencyratioCr

Themoneymultiplierandthemoneysupplyare

negativelyrelatedtoCr

ChangesintherequiredreserveratioRRr


negativelyrelatedtoRRr

ChangesintheexcessreservesratioERr


negativelyrelatedtotheexcessreservesratioERr

CreditCreation:FactorsthatDetermine

theMoneyMultiplier


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FactorsthatcauseCrtochange.

Changesinincome/wealth

Largerproportionsofcurrencyareheldbypeoplewithlowincome/wealth

Asincome/wealthrises,theratioofcurrencytodepositsfalls

Changesinexpectedreturns

Asthe

interest

rate

on

deposits

rises,

Cr

falls

Asthecostofacquiringcurrencyfalls,Crrises

Fearsofbankinsolvency(i.e.bankpanics)causeCrtorisesharply

IncreasesinillegalactivitycauseCrtorise


theMoneyMultiplier

ChangesintheCurrencyRatio(Cr)

Whatarethecostsandbenefitstobanksofholdingexcessreserves?

MarketInterestRates()

Theopportunitycostofanexcessreserveisinterestrateearnedforgone.Asmarketinterestratesrise,thisopportunitycosts

increasesand

banks

hold

fewer

excess

reserves

ERrisnegativelyrelatedtomarketinterestrates

ExpectedDepositOutflows(+)

Themainbenefitofholdingexcessreservesisthattheyinsulatethebank(somewhat)fromsuddendepositoutflows.Withexcessreserves,banksdonothavetocallinloans,selloffotherassets,orborrowfromtheRBItocoverdepositsbeingwithdrawn

Ifbanksthinkthatdepositoutflowswillincrease,theywouldbewisetoincreasetheirexcessreserveratio

ERrispositivelyrelatedtoexpecteddepositoutflows.


theMoneyMultiplier

ChangesintheExcessReserveRatio(ERr)


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RBIcanincrease/decreasethemoneysupplybylowering/raisingthereserveratio(RRr)i.e.CRRandSLR.

ByincreasingordecreasingtheCRRandSLRRBIcaninfluenceMoneySupply.

BankshavefoundthattheyneedtokeepextracurrencyinATMsoverweekendsandholidays. Thiscurrencyisclassifiedasvaultcashandcountstowardrequiredreserves

IfRRr isnotbinding,thenanychangeinRRr willhavelittletonoeffect.(onlyworksifyousignificantlyincreaseRRr!)


theMoneyMultiplier

ChangesintheRequired ReserveRatio(RRr)

Credit Creation

High Powered Money and Money Multiplier in India


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Credit Creation: Money Multiplier

The change in the money multiplier need not necessarily be policy induced.

It can also reflect an endogenous change in the behaviour of the holders of the

components of broad money.

Credit Creation

High Powered Money and Money Multiplier in India


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Bank credit

Deficit financing

Foreign exchange reserves

Government Expenditure

FII inflows

Factors affecting Money supply: Summary

Demand for Money


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Demand for Money

What is Demand for money?

Demand for money means the willingness and ability tohave money at a specific price a point of time

What determines demand for Money??????

Different schools of thought

Classical Economists

Keynesian Economists

Post Keynesian

Baumol and Tobin Monetarist Economists

Origin of Demand for Money:

is the Quantity Theory of Money(QTM)

1.Classical Theory of Money and Interest

A) Fishers (1911) Quantity Theory of Money and Price Level :

MV = piqi ...(1) Original

MV = PT .(2) Fisher Version

where M = quantity of money in circulation

V = transaction velocity of circulation of money i.e. no of times moneyused to purchase output

pi= price of each output, qi = real output

P = weighted average price level or general price level

T= Sum of all transactions of goods and services per unit time

If we Include Money Supply created by banks though DD, than eq become

MV+MV=PT (3)

Classical Economists

money is demanded for

transaction purpose

1568 byJeanBodin, FrenchPhilosopher1911 byIrvingFisher:Mostpopularandrepresents

classicaltheory


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)8...().........(,

/,

;

)7...(,.........,

1,),6.........(

1

,,:

1

:..........

YfMSo

kyPMor

TPYwhere

kYMor

VkwhereTkPM

TPV

M

MMandMMiumForEqilibr

TPV

M

ionFisherVersQTMTPVM

d

d

d

d

d

ssds

Md/P is the real cash balance

People need money to buy goodsand services.

So money is demanded for

transaction purpose and it depends

upon level of income

Here M denotes Money Supply

a. QTM as Theory of Price Level: P=(MV+MV)/T

b. QTM as Theory of Demand for Money: MS= Md

Given Money Supply


There has been a secular decline in the velocity in the post-independence era reflecting

monetization ( maybe due to NAREGA)and commercialization of the economy.

The income velocity of money is stable in short run in recent years.

The decline in velocity accelerated in the aftermath of the global economic crisis reflecting the

weakness in credit demand and preference for liquidity

Velocity of Circulation of Money



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Classical Theory of Interest Rate

Classical: Classical theory says equilibrium between

Md and Ms determines Price level and

not the interest rates

Keynesian: Keynes first developed the theory of

interest rate for the classical economists and

said equilibrium between Md and Ms

determines the interest rate . This is called as

Loanable Fund Theory of Interest Rate or

Neo-Classical Theory of interest rate.


Keynesian Theory of Demand for Money

People hold money in two alternative form1. Cash/Currency

2. Bonds or Securities,

So, 3 Motives of holding for money

1. Transactions motive : people hold moneyto buy stuff

Md rises as income rises,

2. Precautionary motive : people hold money

for emergencies

Md rises with income

3. Speculative motive: suppose store wealth

as money or bonds high interest rates

bonds more attractive, hold less money

Md negatively related to interest rate

_

P is fixed in entire Keynesian Models

2. Keynesian Theory of Money and Interest


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MTd=f(Y).(10)

and MPd=f(Y)(10)

So, MTd=k(Y). (10a) k>0

and MPd=k(Y). (10b) k>0

k is constant proportion of money demand from Income for transaction

purpose in transaction demand for money and also the same in

precautionary demand for money.


MTd

Y

Transaction and Precautionary demand for

money is interest inelastic.

Total Money Demand: Md=MTd+Mp

d

=>Md=kY(11)

Md

YQty of money demand for transaction

and precautionary purpose


3. Speculative Demand for Money

MSpd=f(i) (12) i>0 and Msp

d/ i Mspd=Lo-h*i. (13) Speculative demand for money

h is constant proportion of money demand from interest rates


Liquidity trap means a min rate of interest

beyond which interest rate can not fall and

people wish to hold entire money in idle cash

balance.

In the United States and Europe in

20082010, as short-term policy

rates for the various central banks

moved close to zero.

In many developed world during

2008-11 including US, Japan and

Europe were under liquidity trap



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Total Demand for Money: Sum of all these demand functions

We know, MT&Pd=f(Y)

MSpd=f(i) i>0 and Msp

d/ i Md=MTd+Mp

d+Mspd.(14)

=> Md=kY+L0-hi ..(15)

So, Md=f(Y,i) . (16)

Real money demand depends upon real output and overall interest rates.




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Criticism of Keynesian demand for Money and Liquidity Trap

1. Division between Mtd, Mp

d and Mspd is unreliable.

2. Normal rate of interest and current rate of interest are not the same.

If current rate of interest is stable people take it as normal rate of interest.

According to Keynes speculative demand for money is governed by this

difference.

3. For Keynes only two assets, money or bond. But in reality people can

hold money in different assets.

4. Criticism of Liquidity Trap:

Expansive monetary policy could still stimulate the economy via the

direct effects of increased money stocks on aggregate demand,

Ex. 1. Bank of Japan MS 2. US and Europe MS during 2008-09

No evidence of the existence of a liquidity trap for an interest rate

greater than zero


Keynesian theory of Money and Interest Rate

Keynes says , the equilibrium between demand and supply of money

determines determines interest rate

We know Mt+Msp=Md

=>Mt+Msp=Ms where Ms is fixed

=>Md=kY+L0-hi



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Keynesian theory of Money and Interest RateChange in Money Market and Interest Rate

1. Change in Demand for money

1. Change in Transaction Demand

2. Change in Speculative Demand


Keynesian theory of Money and Interest Rate

Change in Money Market and Interest Rate

2. Change in Money Supply



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Friedmans Modern Quantity theoryMiltonFriedman(1968)

Moneyisdemandjustlikeanyotherdurablegoods.

Moneyasasterileformofwealthandmoneyisdemandedforstoringwealth.

Md asassetdemand.

Wealth

Returnrelativetootherassets

DeterminantsofDemandforMoney

UltimateWealth

Holders

TotalWealth:human+nonhuman

ProportionoftotalwealthtohumanWealth(w)

Expectedrateofreturnonmoney(rm)andfixedassets(rb),equities(re)

Othervariablesaffectingtheutilityofmoney(u)

3. Post Keynesian Theory of Demand for Money

o Yp = permanent income

o W= wealth

o rb = expected bond return

o rm = expected money return

o re = expected equity return

o e = expected inflationo rb - rm = relative return on bonds

o e = expected return on goodso u=other variables affecting utility of money

o increase in Yp will increase Md

o increase in relative returns of bonds, equity or money

decrease Md

Friedmans Modern Quantity theory

),,,,,,,( , urrrrrrrwYfP

Mmemmbembp

d


Wealth holders Demand function for Money


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Friedmans Modern Quantity theory

Implication of 3:

Md

Y= f(Y

P) V=

P f(YP)

Since relationship of Yand YPpredictable, 4 implies Vis predictable: Get Q-

theory view that change inMleads to predictable changes in nominal income, PY

Theory of asset demand: Md

function of wealth (YP) and relative R

eof other

assets

Md

= f(YP, r

b r

m, r

e r

m,

e r

m)

P +

Differences from Keynesian Theories

1. Other assets besides money and bonds: equities and real goods

2. Real goods as alternative asset to money implies M has direct effects

on spending3. r

mnot constant: r

b, r

m, r

b r

munchanged, so M

dunchanged: i.e.,

interest rates have little effect on Md

4.Md

is a stable function


References:

Handout supplied to you on Money:

Demand and Supply

Ch 11,12,13,14,15 Macroeconomic

Theory and Policy by D N Dwivedi

Ch 4 and 25, Macroeconomics by

Blanchard


35/35

Thank You All

s6m money supply and demand

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