Equilibrium in Money Market

9 Key excerpts on "Equilibrium in Money Market"

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  eBook - ePub

  Applied International Economics

  • W. Charles Sawyer, Richard L. Sprinkle(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  Figure 15.4 . This equilibrium in the money market occurs as individuals and firms adjust their asset holdings. For example, at any interest rate higher than the equilibrium rate, the amount of money demanded by individuals and firms is less than the amount of money supplied. In this case, individuals and firms would buy financial assets that earn an explicit rate of return. By purchasing financial assets, the price of financial assets would rise, causing a fall in interest rates until the money market achieves equilibrium. Conversely, if the interest rate is below the equilibrium rate of interest, the amount of money demanded by individuals and firms is greater than the amount supplied. As a result, individuals and firm would sell financial assets, causing the price of such assets to fall and interest rates to rise.

  FIGURE 15.4

  The equilibrium interest rate

  Now that we know how the equilibrium interest rate is determined, we can illustrate how the interest rate responds to changes in either the demand or supply of money. For example, assume that the money market is in equilibrium and the real income or the price level changes. A change in either one of these determinants shifts the demand for money and changes the equilibrium interest rate. Two examples of these changes in money demand are shown in Figure 15.5 . First, assume that the money market is in equilibrium at point E, and the economy has an overall decline in real income. Such a decline in total real income is usually associated with a recession. As real income declines, the demand for money declines. This is represented by a shift in the demand for money from MD to MD1 . As a result, the new equilibrium in the money market is at F, and the equilibrium rate of interest declines to i1

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  eBook - ePub

  Islamic Capital Markets

  Theory and Practice

  • Noureddine Krichene(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  An equilibration process will tell us how the money market actually moves to a situation where everybody manages to meet their desired behavior (given from the behavioral functions). The supply of money is the total stock of money available for use in transactions and speculation and held by the private sector. The demand for money balances is the total stock of money that the private sector wishes to hold. Note that when we change the supply of money, we are changing the amount in deposit accounts. At any instant in time, all the money has to be somewhere: every dollar of the money supply must be held by someone.

  If the demand for money is at M 1 there is an excess supply of money equal to M 1 − M ; private money holders would like to reduce their money balances and acquire income earning assets; there is a bond buying spree that drives up bond prices and therefore reduces interest rates; as interest rates fall, there are private money holders who might be enticed to increase their demand for cash balances. The reequilibrating process operates until equilibrium is achieved and bond and money markets are in equilibrium. In contrast if the demand for money is at M 2 there is an excess demand equal to M 2 − M ; there are private money holders who wish to increase their money holdings; they wish to sell bonds or acquire less bonds; this translates into a fall in demand for bonds, a fall in their prices, and a rise in interest rates; at higher interest rates, some private money holders may wish to reduce their demand for money in favor of income earning assets. The equilibrium process operates until equilibrium in which money and bond markets clears.

  Money market equilibrium is a stock equilibrium and occurs at the interest rate at which the quantity of money demanded is equal to the existing stock of money in the economy. Figure 16.1 combines demand and supply curves for money to illustrate equilibrium in the market for money. With a fixed stock of money M , the equilibrium interest rate is i

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  Collected Papers on Monetary Theory

  • Robert E. Lucas Jr., Max Gillman, Robert E. Lucas, Jr., Robert E Lucas, Max Gillman(Authors)
  • 2013(Publication Date)
  • Harvard University Press

    (Publisher)

  A formal definition of a monetary equilibrium with a constant money supply M which embodies this convention is developed by means of the optimal value function v ( m ), interpreted as the value of the objective function (1.1) for a consumer who begins the current period with nominal balances m and behaves optimally. This function v must satisfy: v m U c v m c m ( ) max { ( ) ( )} , = + ¢ ¢³ 0 b (1.2) subject to m ¢ = m  pc + py (1.3) m ³ pc. (1.4) Here p is the constant equilibrium price level, c is current goods consump-tion and m ¢ is end-of-period balances. (1.3) is the standard budget con-straint, and (1.4) is the cash-in-advance constraint discussed above. Then in terms of v , equilibrium is defined as follows. 2 definition. An equilibrium in the certainty economy is a number p ³ 0 and a continuous, bounded function v : R +  R such that 2. An alternative to this definition would be to define an equilibrium as an element of a space of infinite sequences { c t , p t , m t } of consumptions, prices and money demands, satisfy-ing feasibility, utility maximization and market clearing. In this alternative set-up, the equilibrium specified below (a constant sequence) is the only one, but this must (and can) be argued using a “transversality condition.” The “stationarity” built into the definition used here will prove convenient in the section following. Whether it rules out any behavior of economic interest is not known, though my own opinion is that, in the present context, it does not. 3 n Equilibrium in a Pure Currency Economy 49 (i) given p , v satisfies (1.2)  (1.4) (ii) ( c, m ¢ ) = ( y, M ) attains v ( M ). That is, consumers behave optimally (condition (i)) and money demand equals money supply (condition (ii)). Enough has been said already to make it clear that the unique equilib-rium on this definition involves p = M / y and v ( M ) = u ( y )/(1  b ).

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  Monetary Economics

  Policy and its Theoretical Basis

  • Keith Bain, Peter Howells(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  To test for this, we need a clear definition of money and the argument above suggests that this should be a narrow defini-tion. However, if the supply of money is endogenous, the demand for money loses much of its importance and our need for a precise definition of money is also much diminished. In fact, for much of its history, monetary economics has been dominated by the combined assumptions of an exogenous money supply and a stable demand for money. This was not because very many economists thought that it provided an accurate description of economies in practice. Rather it derived from the view that the economic system could best be analysed by assuming well-informed eco-nomic agents and markets that tend towards equilibrium. In such a world, cur-rent real income is always at its equilibrium level and this level is known. Savings decisions reflect the long-term choice between the present and future consump-tion (of goods and services), a real not a monetary decision. All savings are The meaning of money 14 Pause for thought 1.5 Can you explain why a stable demand for money implies a stable velocity of money? invested and the level of investment determines the rate of growth of capital stock, which in turn ensures the desired future level of output. The real rate of interest is determined by the actions of savers and investors. The plans of eco-nomic agents are always fulfilled. There is no uncertainty and no scope for pure-ly financial transactions. The monetary authorities determine the rate of growth of the money supply. Given the stable demand for money, the control of the money supply provides control over the rate of growth of aggregate demand and, with the rate of growth of output determined by real factors, the price level and the rate of inflation. In such a model, money is neutral. We can see this as anoth-er form of the notion that money acts as a veil over the real economy.

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  eBook - ePub

  Collected Papers on Monetary Theory

  • Robert E. Lucas Jr., Max Gillman, Robert E. Lucas, Jr., Robert E Lucas, Max Gillman(Authors)
  • 2013(Publication Date)
  • Harvard University Press

    (Publisher)

  This equilibrium is not a “golden rule” (a stationary state with discount factor β = 1). In contrast to optimal growth paths, however, only the stationary state can be interpreted as an equilibrium: along any approach path, an agent taking prices as given can increase his utility. This seems to me to mirror exactly Friedman’s statement, in a very similar context, that while “it is easy to see what the final position [following a change in M ] will be. .. it is much harder to say anything about the transition” (1969, p. 6). The shape of the equilibrium distribution of real balances is shown in Figure 3. There is a mass point at the institutional minimum holding y, and then a smooth distribution on. The existence of a mass point clearly follows from the economics of the situation: if individuals did not occasionally spend all available cash (return to y) they would be holding too much money. Money is an inventory, held against a particular contingency, and one never has an optimal inventory bounded away from zero. There is, however, no presumption that the lower bound y is visited “frequently” or, which comes to the same thing, that a “large” fraction of consumers will be at m = y at any point in time. Figure 3 The determinants of the demand for money, or of velocity, in this model are a mix of “institutional” and “economic” factors. Clearly, the length of a “day” will affect the equilibrium; indeed, there are economists to whom a constraint of the form pc ≤ M (in units, $/t ≤ $) must appear unthinkable. As long as one remembers not to vary the length of a “day” in mid-argument, this raises no problems, however. Moreover, the rate at which the earth rotates does have important economic implications and there is nothing to be gained in insisting on an economic explanation for this phenomenon. The economic factors affecting money demand are preferences U, the discount factor β, the volatility F of the shocks θ and income y

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  The Pure Theory of Capital

  • F. A. Hayek, Lawrence H. White(Authors)
  • 2011(Publication Date)
  • University of Chicago Press

    (Publisher)

  A. Hahn 10 and J. M. Keynes, of regarding the rate of interest as being solely dependent on the quantity of money and the varying desires of people to keep certain balances of money in hand. We are here not primarily concerned with the transitory or purely dynamic effects of monetary changes on the rate of interest. But if it is true—as we must assume in the light of all evidence—that changes in the quantity of money affect the rate of interest, there must exist, even in equilibrium conditions, some relationship between the quantity of money people want to hold and the rate of interest. It is this relationship which we must first try to elucidate. Extension of Concept of Equilibrium Used Now, as has been pointed out in an earlier chapter, 11 the desire of people to hold money cannot readily be fitted into the rigid definition of equilibrium we have used up to this point. At least, in an economy in which people were absolutely certain about the future, there would be no need to hold any money beyond the comparatively small quantities necessitated by the discontinuity of transactions and the inconvenience and cost of investing such small amounts for very short periods. But the assumption of certainty about the more distant future, although we have so far based our argument on it, is not really essential for our concept of equilibrium. The plans of the various individuals may be compatible with the extent to which they are definite, 12 and yet the individuals may at the same time be uncertain about what will happen after a certain date and may wish to keep some general reserve against whatever may happen in that more uncertain future

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  Fundamentals of Finance

  Investments, Corporate Finance, and Financial Institutions

  • Mustafa Akan, Arman Teksin Tevfik(Authors)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Money supply has various definitions as M1, M2, and M3. Economists believe that the money supply is important in managing economic activity. The interest rate is the cost of money. For banks, interest is paid on savings de-posits; to consumers, interest is paid on loans and credit card balances. Interest can also be defined as the cost of postponing consumption. The nominal interest rate (NIR) is subject to risks of inflation, maturity, default, and liquidity. The yield curve plots yield against time to maturity for default-free securities. 6 For a complete discussion of bank regulation, see S. Dow, “ Why the banking system should be Regulated, ” Economic Journal , 106(436), 1996, pp. 698 – 707. 2.11 Summary 29 The Central Bank in general is a government-established organization responsi-ble for supervising and regulating the banking system and for creating and regulat-ing the money supply. The balance sheet of a Central Bank is an important economic indicator followed by markets. The banking industry is heavily regulated to inform investors properly, insure soundness of financial intermediaries, and improve monetary control. 30 2 Money and Interest Rates

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  The Value of Money

  • Prabhat Patnaik(Author)
  • 2009(Publication Date)
  • Columbia University Press

    (Publisher)

  And once expectations are brought in, there has to be some holding of money for reasons other than its use as a means of circulation, or, what comes to the same thing, the income velocity of circula-tion of money cannot possibly be taken to be constant. The equilibrium value of money, which acts as the center of gravity toward which the short-run value of money would tend to converge in the absence of fresh distur-bances, depends exclusively on the wage rate and the conditions of production, about neither of which is there any mystery. Whenever the current value of money happens to differ from this value, the wealth holders would certainly expect the current value to move toward it. 8 Let us now look at the implications of this fact for Ricardian theory. Let us con-fine ourselves to Ricardo’s own premises (based on Say’s law), namely that the real demand for nonmoney commodities is always equal to their real supply, a proposition that necessarily holds in nominal terms no matter what the prices (whether market A Critique of Ricardo’s Theory of Money 95 or equilibrium prices); and that the excess supply or demand for money, with given output and at equilibrium prices of commodities, can only bring about a deviation of their market prices from their equilibrium prices. In short, all excess demand or supply in the system arises from the money market and not from the commodity mar-ket, that is from too much or too little money being supplied to circulate the output of nonmoney commodities at their equilibrium prices. Let us, for convenience, start from a situation of equilibrium, and assume that sud-denly there is a ceteris paribus increase in money supply. Now, money, even when it is commodity money, has very low carrying costs: indeed the commodities typically chosen as money are precisely those, like gold and silver, whose value relative to their volume is extremely high, resulting in low carrying costs.

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  Keynes

  The Instability of Capitalism

  • Fausto Vicarelli(Author)
  • 2015(Publication Date)
  • University of Pennsylvania Press Anniversary Collection

    (Publisher)

  12. On the Notion of Equilibrium in Economics (Cambridge: At the University Press, 1973), p. 25. THE OUTLINE OF A GENERAL THEORY 179 given, while his method entailing a theory of shifting equilibrium implies the theory of a system in which changing views about the future are capable of influencing the present situation. This is a fundamental consequence of the presence of money, whose importance essentially flows from its being a link between the present and the future. 13 For Keynes the possibility that the relation between money, employment, and prices that governs the scene in this short-term equilibrium may converge in the long run toward simpler propositions is a question for historical general-ization rather than for pure theory. He remarks that the very long-run course of prices has almost always been upward. For when money is relatively abundant, the wage-unit rises; and when money is rel-atively scarce, some means is found to increase the effective quan-tity of money. 14 The average level of long-run employment depends on the historical conditions influencing the marginal efficiency of capital, and on the minimum rate of interest which wealth-owners require in accepting nonliquid financial assets: During the nineteenth century, the growth of population and of in-vention, the opening-up of new lands, the state of confidence and the frequency of war over the average of (say) each decade seem to have been sufficient, taken in conjunction with the propensity to consume, to establish a schedule of the marginal efficiency of capital which allowed a reasonably satisfactory average level of employment to be compatible with a rate of interest high enough to be psycholog-ically acceptable to wealth-owners.

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