Economics
Money Supply and Exchange Rate
The money supply refers to the total amount of money in circulation within an economy, including cash, demand deposits, and other liquid assets. Exchange rate, on the other hand, represents the value of one currency in terms of another. Changes in the money supply can impact exchange rates, as an increase in the money supply may lead to currency depreciation, while a decrease may result in currency appreciation.
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10 Key excerpts on "Money Supply and Exchange Rate"
eBook - ePub- W. Charles Sawyer, Richard L. Sprinkle(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
S o far, we have examined the institutional details of the foreign exchange market and explained what determines the exchange rate. The model of exchange rate determination developed in the previous chapter explains some of the movement in exchange rates. Both the rate of inflation and the growth rate of GDP usually do not change dramatically over short periods of time, such as one day to the next. Yet, exchange rates change almost every minute of every business day. As a result, we need to expand our model of exchange rate determination to include another factor that determines or influences exchange rate movements over short periods of time. This factor is short-term interest rates. Since interest rates have an important influence on the exchange rate, we need to describe what causes domestic interest rates to change. In the first part of the chapter, we will review and expand on what you learned in your Principles of Economics course concerning the supply and demand for money and the determination of the equilibrium interest rate within a domestic economy.In the second part of the chapter, we will examine the relationship between interest rates and the exchange rate. As we will see, any change in interest rates will lead to changes in the inflows and outflows of capital in a country’s financial account and the changes in capital flows lead to changes in the exchange rate. By the end of the chapter, we will be able to examine how changes in interest rates, the exchange rate, the current account, and the financial account all interact with one another.MONEY DEFINED: A REVIEWWhen trying to determine how money affects the exchange rate, our first objective is to define the term money. Most individuals believe that they know what money is, but in fact, what constitutes money is not clear at all. The easiest way to describe money is to consider what it does. Money has to perform three separate but important functions. First, it must act as a medium of exchange. This is money’s most important function. How would economic transactions be conducted in a world without money? Without money, every price would be a relative price. For example, the price of a hamburger would be defined as what a hamburger is worth in terms of all other goods and services. In an advanced economy with a large number of goods and services, this relative pricing quickly becomes untenable. The price of one hamburger might be defined as four soft drinks or .04 tires. No one could possibly keep track of all the possible relative prices. The power of money is largely dependent on solving this relative-price problem. If there are 50,000 goods in any economy, there are only 50,000 prices. This is complicated but the alternative is far more complicated. Even if governments did not produce money, some item would emerge as a medium of exchange. In anything other than the simplest economy, something would emerge to serve as money.1
eBook - PDF- William Boyes, Michael Melvin(Authors)
- 2015(Publication Date)
- Cengage Learning EMEA(Publisher)
2. How is the U.S. money supply defined? credit Available savings that are lent to borrowers to spend. Chapter 12 Money and Banking 255 Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. they measure spendable assets. Identifying those assets, however, can be difficult. Although it would seem that all bank deposits are money, some bank deposits are held for spending, while others are held for saving. In defining the money supply, then, economists must differ-entiate among assets on the basis of their liquidity and the likelihood of their being used for spending. The problem of distinguishing among assets has produced more than one definition of the money supply. Today in the United States, the Federal Reserve uses M1 and M2. 1 Economists and policymakers use both definitions to evaluate the availability of funds for spending. Although economists have tried to identify a single measure that best influ-ences the business cycle and changes in interest rates and inflation, research indicates that different definitions work better to explain changes in macroeconomic variables at different times. 12-1b-1 M1 Money Supply The narrowest and most liquid measure of the money sup-ply is the M1 money supply , or financial assets that are immediately available for spending. This definition emphasizes the use of money as a medium of exchange. The M1 money sup-ply consists of currency held by the nonbank public, traveler’s checks, demand deposits, and other checkable deposits.
- Michael Brandl(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
Here we examine why this is the case and how difficult it actually is to measure the money supply. Finally, one thing we will come back to again and again is the “price of money.” One, but not the only, price of money is interest rates. We take a look at why interest rates exist and how they are used in calculating the today’s value of money we will receive in the future, as well as the value of money in the future that we have today. The changes in the price of money can have a large impact on just how fast, or slow, the economic world goes around and around. 2-1a Money Defined Whenever you begin studying a new concept, it is often best to start with a formal definition. A formal definition of money would read something like this: Money: Anything that is generally acceptable in exchange for goods and services and/or repayment of debt. What does that really tell us? First, notice it says “anything”; there is no mention that money has to come from the government or the central bank, or even from banks in general. Money is something that people “generally accept” in exchange for goods and services. Note that just because a government or central bank issues currency does not mean it will be accepted as money. For example, leading up to the Russian Ruble Crisis of 1999, people in Russia stopped using the official, government-issued ruble in exchange for goods and services. Thus, the ruble was ceasing to be money because it was no longer “generally accepted” by the Russian people. Later in this chapter, we look at how a wide variety of things, including vodka during the Russian Ruble Crisis, has functioned as money over time. At this point, don’t get hung up on the idea that money must be those little scraps of paper issued by the central bank that you are carrying around in your wallet. Remember, money is anything that is generally acceptable in exchange for goods and services and/or repayment of debt.
- Michael Brandl(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Here we examine why this is the case and how difficult it actually is to measure the money supply. Finally, one thing we will come back to again and again is the “price of money.” One, but not the only, price of money is interest rates. We take a look at why interest rates exist and how they are used in calculating the value today of money we will receive in the future, as well as the value of money in the future that we have today. The changes in the price of money can have a large impact on just how fast, or slow, the economic world goes around and around. 2-1a Money Defined Whenever you begin studying a new concept, it is often best to start with a formal definition. A formal definition of money would read something like this: Money: Anything that is generally acceptable in exchange for goods and services and/or repayment of debt. What does that really tell us? First, notice it says “anything”; there is no mention that money has to come from the government or the central bank, or even from banks in general. Money is something that people “generally accept” in exchange for goods and services. Note that just because a government or central bank issues currency does not mean it will be accepted as money. For example, leading up to the Russian Ruble Crisis of 1999, people in Russia stopped using the official, government-issued ruble in exchange for goods and services. Thus the ruble was ceasing to be money because it was no longer “generally accepted” by the Russian people. Later in this chapter we look at how a wide variety of things, including vodka during the Russian Ruble Crisis, has functioned as money over time. At this point, don’t get hung up on the idea that money must be those little scraps of paper issued by the central bank that you are carrying around in your wallet. Remember, money is anything that is generally acceptable in exchange for goods and services and/or repayment of debt.
eBook - PDFIndia's Economic Prospects - A Macroeconomic And Econometric Analysis
A Macroeconomic and Econometric Analysis
- Thampy Mammen(Author)
- 1999(Publication Date)
- World Scientific(Publisher)
Yet it may be worthwhile to capture the economic factors affecting the decisions of the Reserve Bank of India. We present below the traditional money supply function in terms of the monetary base consisting of currency in the hands of the public and bank reserves including cash (B). (6.7) (6.8) Once again either interest rate is significant. In this case the money supply is elastic with respect to the monetary base which may be due to the fact that B and Ml contain C. During the period under consideration C constituted 84% of B. The coefficient of determination of 1 may also be due to this reason. Experiments have shown that disaggregating Ml into Supply and Demand for Money 167 its components can directly bring to bear the tools at the hands of the Reserve Bank to control the money supply. Accordingly we have estimated the following two supply equations. D. Supply of currency and demand deposits (6.9) (6.10) The above two equations relate to supply of currency (CS). In place of RCRG as a measure of deficit, we consider the overall deficit (OD) in Eq. (6.10). It shows very high long run elasticity of supply of currency with respect to both interest rate and overall deficit. This high long run elasticity should be expected because currency is the major component of Ml, and monetization expands currency more than demand deposits. The standard error of the equation is about half that of Eq. (6.9). The high interest rate elasticity is a puzzling result in view of the administered nature of interest rate in general during the major part of the study. The t value for RB in the place of RL in the above equation is 1.91. That equation is, therefore, not presented. (6.11) (6.12) 168 India's Economic Prospects The cash reserve ratio (CRR) is one of the direct tools which the RBI has used frequently in recent years. As expected, supply of demand deposits is inversely related to CRR in both formulations above.
eBook - PDF- Jeffrey Yi-Lin Forrest(Author)
- 2014(Publication Date)
- CRC Press(Publisher)
In order to make up the shortage in the statutory reserves, banks have to reduce their amounts of loans being given out. That would cause the amounts of demand deposit in the banking system to decrease multiple times. So, it can be seen that an increase in the rate of excess reserves could also lead to currency ratio to drop. Mathematically, differentiating the currency multiplier with respect to the rate of excess reserves produces ∂ m ∂ r e = − 1 + r c ( r c + r d + r e ) 2 < 0 That means that as the rate r e of excess reserves increases, the currency multiplier decreases. Therefore, the currency multiplier and the rate of excess reserves are negatively correlated. Besides, from the fact that the partial derivative of the currency multiplier with respect to the rate of statutory reserves is equal to that with respect to the rate of excess reserves, it follows that the effect on the monetary multiplier from increasing the rate of excess reserves is identical to that from increasing the rate of statutory reserves. Their effects are of the same magnitude. 4.2.3 Money supply models Money supply can be seen differently with narrow and general classifications and varied layers. In order to develop money supply models on each layer, the key is to find out the determining factors that affect the money supply. To this end, let us Supply and demand of money 103 start with an analysis of the determining factors at the monetary base level. Through explaining the behaviors of depositors and banks, we will look for the factors that determine the money supply so that money supply models on different levels can be established gradually. The base currency is the currency of the central bank and consists of two parts: One is the non-borrowed money NB , whose quantitative changes the central bank can control through trading securities on the open market. The other part of the base currency is the borrowed currency DL .
eBook - PDFExchange Rate Regimes
Fixed, Flexible or Something in Between?
- I. Moosa(Author)
- 2006(Publication Date)
- Palgrave Macmillan(Publisher)
Transactions in the market for goods and services, such as imports and exports, give rise to demand for and supply of foreign exchange respectively. Equivalently, these transactions lead to the supply of and demand for the domestic currency respectively. (a) Exchange rate 0.60 1.00 1.40 1.80 2.20 1 9 17 25 33 41 49 57 65 73 81 89 97 (b) Foreign currency price 5 7 9 11 13 15 17 1 9 17 25 33 41 49 57 65 73 81 89 97 (d) Domestic currency revenue 600 650 700 750 800 850 900 1 9 17 25 33 41 49 57 65 73 81 89 97 (c) Quantity 60 70 80 90 1 9 17 25 33 41 49 57 65 73 81 89 97 Figure 2.8 The effect of changes in the exchange rate on domestic currency revenue (100 simulations) 38 Exchange Rate Regimes Transactions in financial markets, which are recorded on the capital account, also lead to demand for and supply of currencies. The sale of domestic securities and the purchase of foreign securities give rise to demand for foreign exchange (supply of domestic currency). Conversely, the purchase of domestic securities and the sale of foreign securities give rise to demand for the domestic currency (supply of foreign exchange). The relationship between the balance of payments and the foreign exchange market is, therefore, obvious. For each transaction on the foreign exchange market there is a corresponding entry on the balance of payments. For the purpose of illustrating this relationship further we will examine the foreign exchange market from the perspective of the foreign currency, such that the exchange rate, E, is measured as the domestic currency price of one unit of the foreign currency. Three possible cases are illustrated in Figure 2.9, which shows the demand for and supply of foreign exchange curves (D and S respectively). In Figure 2.9(a), the foreign exchange market is in equilibrium at the exchange rate E 0 , at which the supply of and demand for foreign exchange are equal. This is equivalent to saying that the balance of payments is in equilibrium.
- Herbert Giersch(Author)
- 2019(Publication Date)
- Taylor & Francis(Publisher)
However, this effect is much less marked once the more extreme 1985-1986 observa-tions on US money supply and exchange-rate movements are included in the regressions displayed in Table 3fs bottom panel (1). Changes in the American money supply are just not very good in pre-dicting (cyclical) changes in the American price level over a three-year period. This is not to deny, of course, that money-supply variables dominate the American price level (and exchange rate) over much longer periods. 5. An International Model of American Price Inflation The effect of the exchange rate on the American price level in [3], and displayed in Figures 4 and 5, seems much greater than what can be ex-plained by direct arbitrage in international commodity markets. American exports and imports together still amount to less than 20 percent of GNP. Just looking at the pass through effects of exchange-rate changes on the dollar prices of goods entering American foreign trade - assuming international inflation to be given exogenously - greatly understates the ultimate inflationary impact of, say, a dollar devaluation. There are two additional money-market considerations associated with US changes in E [McKinnon, 1984] that impinge on the American price level. (1) Some readers may be justifiably concerned that the whole analysis so far has relied on Ml to measure the money supply. Because of the erratic behavior of the velocity of American Ml in the 1980s in comparison to the 1970s (Figure 5), many American monetarists have switched over to M2 as their preferred aggregate, and, in February 1987, the Fed itself dropped any official target for Ml. However, if the regressions in Table 3 are rerun substituting US M2 for US Ml, the results (not reported in this paper) are even worse for the domestic monetarist model for the period of floating exchange rates. The regression coefficients on the money supply even have the wrong signs.
- G.C. Harcourt(Author)
- 2019(Publication Date)
- Routledge(Publisher)
Without the information-flows obtained by the use of money (or by some alternative or equivalent informational system), the system could not function. Even with the advantages accruing to the economy from the use of money, the uncertainties are still so pervasive that maladjustments and unemployment occur. A monetary system is, therefore, a necessary adjunct for the development and expansion of a decentralised economy. But the institution of money, which allows such decentralisation within the economy, is then sometimes blamed for the disequilibria which subsequently arise. Indeed this view that the existence of money should reduce disequilibria within a given economy, or allow the greater expansion of an economy with no extra disequilibria resulting, does not seem to be generally accepted within the literature. Consider the following two quotations. The first is by Kessler; in Kessler (1972) he wrote: 1 Holtrop's monetary views are based on the recognition, already stressed by J. G. Koopmans in 1933, that J.B. Say's law of markets does not hold in a money-using economy. In a barter economy every supply of goods implies a demand for goods. This rigid connection between supply and demand ceases to exist when money is used in exchange for goods. It is only in a money-using economy that 'pure demand' (reine Nachfrage) can exist, i.e., a demand for goods that is not met by a corresponding supply. This is the case when the purchasing power for the demand for goods is not derived from current income but from the creation or dishoarding of money. Conversely, there may be a shortfall of demand (reine Nachfrageausfall) when income from production is 'lost' in destruction or hoarding of money.
eBook - PDF- Jan Herin(Author)
- 2019(Publication Date)
- Routledge(Publisher)
The various implications of this approach that go beyond the particular model examined above are also discussed. (i) In the long run there is symmetry between the regime of fixed and flexible exchange rates. Under fixed exchange rates, the exchange rate is exoge-neous and the supply of money endogeneous. Under flexible exchange rates, the supply of money is exogeneous and the exchange rate endogeneous. A devaluation under fixed exchange rates increases the supply of money propor-tionately in the long run; under flexible exchange rates, an increase in the money stock increases the exchange rate proportionately in the long run. An important long-run difference between the two regimes is that under flexible rates the rate of inflation can be varied independently of the rest of the world. Changes in the rate of inflation can be interpreted as changes in the tax on domestic money and they will have systematic effects on the long-run stock of wealth and its composition. Other instruments of fiscal policy can be used in both regimes to alter the stationary state. Because fiscal policy and other real variables have an effect on the long-run demand for money, it is not correct to say that the exchange rate can be explained by monetary factors alone, even in the long run. (ii) The adjustment process is quite different under the two regimes. In both systems, the stock of wealth adjusts to its long run desired level through defi-cits and surpluses in the current account. Under fixed exchange rates portfolio equilibrium between domestic money and foreign assets at a given level of wealth is obtained through instantaneous capital inflows and outflows because the Central Bank supplies foreign assets at a fixed price. Under flexible ex-change rates instantaneous portfolio equilibrium is obtained through changes in the valuation of assets-that is, through changes in the exchange rate. Exchange rate in the short run and in the long run 169 Whereas a desire to hold.
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