Economics
Money Demand Curve
The money demand curve represents the relationship between the quantity of money demanded and the interest rate. It illustrates how the quantity of money that individuals and firms want to hold changes as the interest rate fluctuates. As the interest rate decreases, the quantity of money demanded typically increases, and vice versa.
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10 Key excerpts on "Money Demand Curve"
eBook - ePub- W. Charles Sawyer, Richard L. Sprinkle(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
This is shown as MS 1 in Figure 15.1. On the other hand, if the central bank raises the discount rate, raises the reserve requirement, or sells bonds, the supply of money declines. This is shown in Figure 15.1 as a shift in the money supply inwards or to the left and is represented by MS 2. The demand for money is illustrated in Figure 15.2. Like virtually all demand curves, the demand for money slopes downward, indicating that as interest rates fall, the amount of money that individuals and firms are willing and able to hold increases. This change in the amount of money demanded is illustrated in the figure by moving from point A to point B. As interest rates change, individuals and firms adjust the quantity of money that they are willing and able to hold by moving along the demand curve. Like all demand curves, the relationship between the price and quantity demanded is based on the assumption that everything else has been held constant. In the case of the demand for money, the major determinants being held constant are real income and the price level. If either one of these determinants changes, the entire demand for money will shift. Both increases and decreases in the demand for money (shifts) are shown in Figure 15.3. For example, if the level of real income and/or the price level increase, the demand for money will increase (shift) to the right as indicated by MD 1. On the other hand, if real income and/or the price level decrease, the demand for money will decrease (shift) to the left as indicated by MD 2. FIGURE 15.2 The demand for money FIGURE 15.3 Change in the demand for money By combining the supply and demand for money, we can determine the equilibrium interest rate. Given a particular level of income and prices (demand) and given the supply of money determined by the central bank, the equilibrium in the money market is at point E and the equilibrium interest rate would be equal to i as shown in Figure 15.4
eBook - PDFMacroeconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Along a given Money Demand Curve, the quantity of money demanded relates in- versely to the market interest rate, other things held constant. The demand for money curve shifts rightward as a result of an increase in the price level, an increase in real GDP, or an increase in both. 2. The Fed determines the supply of money, which is assumed to be independent of the interest rate. The intersection of the supply and demand curves for money determines the market interest rate. In the short run, an increase in the supply of money reduces the interest rate, which increases investment. This boosts aggregate demand, which increases real output and the price level. 3. The long-run approach focuses on the role of money through the equation of exchange, which states that the quantity of money, M, multiplied by velocity, V, the average number of times each dollar gets spent on final goods and services, equals the price level, P, multiplied by real output, Y. So M 3 V 5 P 3 Y. Because the aggregate supply curve in the long run is a vertical line at the economy’s potential output, a change in the money supply affects the price level but not real output. 4. Between World War II and October 1979, the Fed tried to maintain stable interest rates as a way of promoting a stable investment environment. During the 1980s and early 1990s, the Fed paid more attention to growth in money aggregates, first M1 and then M2. But the velocity of M1 and M2 became so unstable that the Fed shifted focus back to interest rates, particularly the federal funds rate. To pursue its mandated goals of price stability and maximum employment, the Fed uses open-market operations to adjust the federal funds rate, raising the rate to prevent higher inflation and lowering the rate to stimulate employment.
eBook - PDFMonetary Economics
Policy and its Theoretical Basis
- Keith Bain, Peter Howells(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
However, since the model does not assume any general uncertainty in the economy and since risk is defined as the standard deviation of a normal distribution, this is unlikely. Certainly, there is no possibility of the demand for money curve shifting in response to an increase in the stock of money. 11 Keynesian developments of The General Theory helped to restore the view that monetary policy through changes in the money supply (continuing to assume an exogenous money supply) might be useful since, if the demand for money were stable, the monetary authority would at least have a good idea of the likely effec-tiveness of monetary policy. Nonetheless, Keynesian economics continued to give considerable importance to fiscal policy. 3.7 Monetarism and the demand for money The term ‘monetarism’ was first used by Brunner (1968) and has since been defined in a variety of ways. Mayer (1978) identifies twelve propositions associ-ated with monetarism, but we shall be content with his ‘narrow meaning’ — the view that changes in the money stock are the principal cause of changes in nominal income . In line with this, we continue to assume an exogenous money supply and concentrate on Milton Friedman’s demand for money. Money is demanded by two groups: (a) ultimate wealth holders (for whom money is simply one way in which they may hold wealth); and (b) business enterprises (for whom money is a productive resource). The theory concentrates on ultimate wealth holders. Their demand for money can be analysed in the same way as the demand for any asset. We can con-sider the demand for money as a whole rather than needing to consider separate 'motives' for holding money. Thus, the demand for money function contains: Monetarism and the demand for money 81 Pause for thought 3.9: When interest rates rise, is it the income or the substitution effect that causes the demand for money to fall? Why?
eBook - PDF- Subrata Ghatak, José R. Sánchez-Fung(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
These authors formulate an inventory-theoretic model postulating ............................. Money demand 83 that the transaction demand for money may depend on the short-run interest rate. The reason is that firms can earn interest by holding transactions balances in the form of short-term liquid assets other than money. The demand for transaction balances is M D P = 0 5 2 bY R (6.2) In Equation (6.2) M D is the demand for nominal balances; P is the price level, and b is a brokerage fee payable every time a firm converts short-term interest-yielding assets into cash. One of the main implications of this theory is that a given increase in the money supply might have a more than proportionate effect on money income. 6.2.3 Portfolio demand By setting a framework that links the interest rate risk and the demand for money in the spirit of Keynes’ speculative motive, Tobin (1958) indicates that while utility derived by the individual from his/her portfolio of assets depends positively on the expected return from the portfolio, it also varies inversely with the risk attached to the portfolio. In this situation the demand for money takes the form: M D P = f R W (6.3) where W is the individual’s non-human wealth, and is a measure of the degree of risk derived from holding bonds. In his ‘restatement’ of the quantity theory – considered as the ‘modern quantity theory’, and closely related to Tobin’s portfolio approach in that it considers the primary role of money as a form of wealth – Milton Friedman (1956) draws attention away from the Keynesian motives that encourage the holding of money. Instead, he analyses factors determining how much money people want to hold in diverse circumstances – see Chapter 5 for a more detailed exposition on monetarism.
- Shigeyuki Hamori, Naoko Hamori(Authors)
- 2009(Publication Date)
- World Scientific(Publisher)
Money demand increases when output increases, and decreases when interest rates increase. We apply two types of specifications corresponding to equa-tion (2.1), as follows: Model 1: ln( M t ) − ln( P t ) = β 0 + β 1 ln( Y t ) + β 2 R t + u 1 t β 1 > 0, β 2 < 0 (2.2) Model 2: ln( M t ) − ln( P t ) = β 0 + β 1 ln( Y t ) + β 2 ln( R t ) + u 2 t , β 1 > 0, β 2 < 0 (2.3) 2 M1 comprises currency, i.e. banknotes and coins, and overnight deposits. M2 comprises M1 and, in addition, deposits with an agreed maturity of up to two years or redeemable at a period of notice of up to and including three months. M3 comprises M2 and certain debt instruments of the resident MFI (Monetary Financial Institutions) sector, namely those used in repurchase agreements, money market fund shares/units and debt securities with a maturity of up to and including two years (including money market paper). ( Source : http://www.oenb.at/en/geldp_ volksw/ geldpolitik/strategie/eurosystems/ components_of_m3.jsp). Empirical Analysis of the Money Demand Function in the Euro Area 35 where u it ( i = 1, 2) is the error term at time t with zero mean and finite variance. Equation (2.2) uses the level of interest rates and equation (2.3) uses the logarithmic value of interest rates. Otherwise, the two equations are the same. 2.3. Aggregate Data Analysis 2.3.1. Data The European Union introduced the euro in January 1999. We therefore set the sample period from that month through to December 2007. We begin here by conducting an empirical analysis with aggre-gate data from the euro area. Three types of money supply data are examined: M1, M2 and M3. The ECB uses M3 as the reference value for its monetary policy. Here, however, we use all three variables in order to analyze the stability of the money demand function from a broader perspective. Each type of money supply is seasonally adjusted by X12.
eBook - PDF- Robert E. Lucas Jr., Max Gillman, Robert E. Lucas, Jr., Robert E Lucas, Max Gillman(Authors)
- 2013(Publication Date)
- Harvard University Press(Publisher)
See Laidler (1977) and, more recently, McCallum and Good-friend (1987) for some of the relevant background. 248 Collected Papers on Monetary Theory recent summary, it is difficult to find clear statements of what the money demand function is. As quantitative economists we often seem to be, in Samuel son’s (1947) phrase, “like highly trained athletes who never run a race, and in consequence grow stale.” Meltzer ran this particular race, in 1963, and turned in his two num-bers. Much has happened since to monetary theory and to the develop-ment of econometric methods, and almost three decades of new data have since become available. In Section II I will summarize the evidence on the income (or wealth) and interest elasticities of money demand from 1900– 58 data, essentially identical to those Meltzer used. Section III introduces a utility-theoretic framework for thinking about money demand, from which I will conclude that there is some reason to view these two parame-ters as structural. Section IV reviews U.S. time series evidence from the 1958–85 period, a period during which nominal interest rates reached lev-els about twice the highest levels attained in the U.S. in the earlier years of the century. Remarkably, in view of the stringent nature of the experiment, these new data precisely confirm the estimates Meltzer obtained in 1963. II. Review of the Evidence from 1900–1958 The hypothetical household decision problem underlying the results re-ported in Meltzer (1963) is that of allocating a given stock of wealth across different assets, given a vector of asset returns. I will come back to this problem in more detail in Section III, but I have said enough to rationalize a demand function for money of the form M P f r w = ( , ).
eBook - PDFFundamentals 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
eBook - PDFIndia's Economic Prospects - A Macroeconomic And Econometric Analysis
A Macroeconomic and Econometric Analysis
- Thampy Mammen(Author)
- 1999(Publication Date)
- World Scientific(Publisher)
The results also indicate that the effect of the deficit on the monetary base cannot be offset by any feasible changes in the monetary tools considered in the model; viz., the bank rate and SLR. We are, therefore, postulating a model more in sympathy with the post-Keynesian endogeneity argument, which seems to be valid for the Indian economy. 6.4. Estimates of the Monetary Sector Demand Function for Money A. Demand for money Currency forms the major portion of the narrowly defined stock of money in India. We, therefore, present two separate demand functions for currency (C) and demand deposits (D). (6.1) C = Stock of currency with the public GDP = Nominal Gross Domestic Product RB = Short rate of interest represented by the inter-bank borrowing rate. Z9093 = 1 for the years 1990 to 1993. It is justified because of the monetization of government debt and inflow of capital. Government debt measured by the RBI credit to government averaged 294.52 billion rupees during 1981-93, and 568.41 billion rupees during 1992-1993. RB is significant, though its elasticity is small. Demand for currency has unit elasticity with respect to GDP. The DW statistics is somewhat less than the critical value. 164 India's Economic Prospects Despite the problems raised by Chick and referred to in Sec. 7.1, we have estimated the demand function in real terms with nominal interest rate. Currency deflated by IP_GDP is (RC). RGDP, nominal RB, the dummy variable Z9093, and the lagged variable are used as arguments in the fuction. The estimated equation follows. (6.2) The long-run income elasticity is about one. This is in conformity with the Cambridge formulation. In the previous equation where nominal quantities are used without the lag structure we obtain a unitary income elasticity. No serial correlation is present in the above equation as judged by the DW or H statistic.
eBook - ePub- Rousseas(Author)
- 2016(Publication Date)
- Routledge(Publisher)
It is dependent mostly on the level of economic activity in nominal terms (Y). In the Treatise the parameters for this demand function, as we have seen, were: (1) the character of production, (2) the habits of the public and the business world, and (3) the opportunity cost of holding cash balances, i.e., the interest income foregone. A fourth parameter should also be added to the three cited by Keynes, namely, (4) the underlying institutional structure of the financial sector of the economy and its stability, i.e., the absence of rapid financial innovations. Assuming all four to be constant, then the demand for transactions balances is determined by the current pace of production in the industrial sector, or L 1 = L 1 (Y). In the Treatise, however, Keynes explicitly allowed the demand for "cash deposits" to respond to the rate of interest: "[W]hen business is active and the cost of borrowing high, firms will tend to economize in the amount of Business-deposits A which they keep" (italics supplied); that is, the velocity of circulation of Business-deposits A will rise. In the General Theory, Keynes toned this down to a "first approximation" in which L 1 is completely inelastic with regard to the rate of interest. The rate of interest was reserved for the dominant role it was to play in the L 2 demand function for idle balances held as a store of wealth—within which the financial sector of the Treatise was now to be found. The L 1 demand for money is shown in Figure 3.2 as a straight line through the origin with nominal income (Y) on the vertical axis and the demand for transactions, or active, balances (L 1) on the horizontal axis. The tangent of angle a is Y/L 1, which can be written as Y/M 1 since the transactions demand for money has priority over the L 2 demand for idle balances and is the first to be satisfied out of a given exogenous money supply—with the residual, M 2, remaining to satisfy the L 2 demand for speculative balances
- Gang Yi(Author)
- 2019(Publication Date)
- Routledge(Publisher)
In the next section, we will derive the money demand functions that reflect the characteristics of the Chinese economy. In particular, we will incorporate inflationary expectations and the monetization process into the money demand functions. 164 The Demand for Money 11.4 Money Demand Functions and Empirical Results The important consideration for money theory and policy is whether the demand for money can be treated as a reasonably stable function of a fairly small number of variables and whether this function can be empiri-cally specified with reasonable accuracy. Friedman (1966) made the above eminent comment twenty-five years ago, the main point of which can still serve as the guideline of estimating the money demand in China today. In this section, we first discuss alternative money demand models based on the theoretical exposition of the previous sections. We then estimate the money demand functions by using annual data for the period of 1952-1989 and quarterly data for the period 1983-1989. Deri11ing the Money Demand Models The discussion of Section 11.1 suggests two points. First, lack of fi-nancial securities does not spoil the analysis of money demand, provided that people have consumer goods as an alternative. Second, there has been no persistent forced saving for the period under study. Consequently, we assume that money demand is by and large equal to the money sup-ply. Therefore, the models discussed below are more or less equilibrium models rather than disequilibrium models. 3 The discussion of Section 3 in-dicates that the monetization process and inflationary expectations were most significant developments during reform and played important roles in determining the demand for money in China.. These two factors will be incorporated in the money demand models in an estimable manner.
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