Shift in Money Demand Curve

7 Key excerpts on "Shift in Money Demand Curve"

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  eBook - PDF

  Macroeconomics

  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.

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  A Systems Perspective on Financial Systems

  • Jeffrey Yi-Lin Forrest(Author)
  • 2014(Publication Date)
  • CRC Press

    (Publisher)

  So, it can be seen that the situation when the demand for money is equal to the money supply represents a relatively static state of equilibrium. It is such a state that ultimately determines the market interest rate. This state is known as the equilibrium of the money market, the corresponding interest rate the equilibrium rate. Hence, the solution i ∗ of the equation M d ( i ) = M s is the market interest rate determined through money supply, the equilibrium interest rate. In Keynes’ theory of money supply and demand, there are two factors that cause the position of the demand curve to move: income level and price level. No matter which one of these factors goes up, the demand curve of money will move rightward. Keynes believes that during periods of economic expansion, income increases and wealth increases so that people like to have more money to store their values. On the other hand, with the economic expansion, the increasing income motivates people to complete additional transactions. Consequently, people are willing to hold more money. What can be concluded from this observation is that along with the increase of income, the demand for money at each interest rate level increases so that the demand curve of money moves to the right. Keynes also believes that what people care about is the actual quantity of money they hold, which is the amount that can be used to purchase goods and labor. When the price level goes up, the purchasing power of money goes down. The same amount (the nominal amount) of money can purchase less goods and labor after the price level increases. So, increasing price level causes the actual amount of money people hold to decrease. In order to recover the actual amount of money held to the level before the price level increases, people would hold more money. That implies that increasing price level causes the demand for money to rise and the demand curve of money to move to the right.

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  The Economics Companion

  • Graham Mallard(Author)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  This is shown in Figure 9.9a as the vertical line denoted (M/P). Key term: the nominal and real money supply The money supply refers to the amount of money in the economy, which can be assumed to be determined by the government. There are two specific types of the money supply. The first is the nominal money supply , which is the amount of money in the economy measured in terms of current money, meaning it’s simply the number of units of the domestic currency flowing round the economy’s circular flow of income. The second is the real money supply , which is a measure of what the money in the economy can buy – its actual value. The real money supply is calculated by dividing the nominal money supply by the price level in the economy, where the price level is the average price across the economy. The demand for money, on the other hand, is represented by the liquidity preference curve (LP). This demand refers to the desire of actors in the econ-omy to hold their wealth as cash rather than as assets that earn them a financial return. In other words, it refers to the preference that people have for liquidity (cash is completely liquid, meaning that it can be used immediately, whereas other assets are often less liquid, meaning it takes time for people to be able to use the wealth they represent) – the demand for money and liquidity prefer-ence mean the same thing. Keynes conjectured the demand for money is com-posed of three parts. 1 Transactionary demand for money . The first reason why economic actors want to hold money is to buy products. This motive for holding money is a positive function of income: as actors enjoy greater income they desire greater consumption and so need to possess larger amounts of money. 2 Speculative demand for money . The second reason why actors want to hold money is to make a return on investments.

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  Intermediate Macroeconomics

  • Robert J. Barro; Angus C. Chu; Guido Cozzi, Robert Barro, Angus Chu, Guido Cozzi(Authors)
  • 2017(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  This real demand is lower along the dashed upward-sloping dashed line, ( M d ) ' , than along the upward-sloping solid line. The nominal quantity of money supplied, M s , is the constant M , shown by the vertical line. The decrease in the real demand for money raises the equilibrium price level from P* to ( P* ) ' on the vertical axis. ' ' Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 205 Chapter 11 The demand for money and the price level THE CYCLICAL BEHAVIOUR OF THE PRICE LEVEL In Chapters 9 and 10, we used our equilibrium business-cycle model to study how shifts to the technology level, A , create economic fluctuations. Now, we can use our analysis of the demand for money to determine how the price level, P , moves during economic fluctuations. Recall that the nominal demand for money is given by: = M P D Y i • ( , ) d (11.2) Thin k about a recession, in which real GDP, Y , falls. The decline in Y reduces the real quantity of money demanded, Y Y given by D ( Y , i ) on the right-hand side of equation (11.2). However, we also found that the interest rate, i , tends to fall in a recession. The decrease in i raises the real quantity of money demanded, D ( Y , i ). The overall change depends on the magnitudes of the decreases in Y and i , and on the sensitivity of D ( Y , i ) to Y and Y Y i . Typical estimates indicate that the real quantity of money demanded, D ( Y , i ), declines overall in this situation; the fall in i tends to be small, and D ( Y , i ) is not very responsive to changes in i . Therefore, we assume that, in a recession, the real quantity of money demanded, given by D ( Y , i ), decreases overall. We can use Figure 11.3 to determine the effect of an economic contraction on the price level, P . Recall that this figure applied to a decrease in the real demand for money, D ( Y , i ), caused by a change in transactions technology.

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  Monetary Economics

  Theories, Evidence and Policy

  • David G. Pierce, Peter J. Tysome(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  The empirical evidence The various theories of the demand for money which were surveyed in the last section, all contain hypotheses which can be, and to a greater or lesser extent have 72 The demand for money been, subjected to empirical testing. The Keynesian analysis, for example, predicts that the demand for money is interest-elastic, and that at some low rate it is infinitely so. The more modern theories of the transactions demand for cash predict that the demand for money will increase less than proportionately to increases in income, while the risk-aversion analysis suggests that changes in the riskiness of bond-holding will affect the demand for money at given interest rates. The monetarist approach says that the demand for money is a stable function of a small number of variables and that wealth rather than current income is the relevant constraint. Very simply, the typical demand for money study has involved a relationship in which the demand for nominal money balances is a function of (i) real income or wealth; (ii) a measure of the opportunity cost of holding money; and (iii) the price level. Sometimes the demand for money is assumed to be unit elastic with respect to the price level, and a relationship used in which the demand for real money balances is a function of (i) and (ii) above. Thus an equation typical of demand for money studies would be = α · yP' · i^' (3.24) where M^ is the demand for nominal money balances, Y the nominal level of the income or wealth constraint, / the appropriate rate of interest, and ßi and ß2 the income and interest elasticities respectively. In logarithms equation (3.24) is linear, giving Log = Log α + ßiLog Y + ßzLog / (3.25) The logarithmic form has the advantage that the coefficients ßi and ß2 are direct estimates of the income and interest elasticities respectively. As it stands however, equation (3.25) does not allow for time lags in the adjustment of actual money balances to their desired levels.

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  eBook - ePub

  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  1

  The money supply and the money stock are identical in the case where the money supply is exogenously determined, usually by the policies of the central bank. In such a case, it is independent of the interest rate and other economic variables, though it may influence them. In this case, the money supply ‘curve’ will be a vertical line, as shown by the line M s in Figure 2.1b , with the money supply as M 0 . Much of the monetary and macroeconomic reasoning of a theoretical nature assumes this case, so that the terms ‘money stock’ and ‘money supply’ are used synonymously. One has to judge from the context whether the two concepts are being used as distinct or as identical ones.

  Note that the symbol M in Figures 2.1a and 2.1b can represent any of the relevant money supply variables, i.e., M 1, M 2, etc. These symbols were defined earlier.

  The control of the money supply rests with the monetary authorities. Their policy with respect to changes in the money supply and interest rates is known as monetary policy.

  2.3 The Nominal Versus the Real Value of the Money Supply

  It is important to distinguish between the nominal and the real value of the money stock. The nominal value of money is in dollars — i.e., in term of money itself as the measuring unit. The real value of money is in terms of its purchasing power over goods and services. Thus, the nominal value of a $1 note is 1 — and that of a $20 note is 20. The real value of money is the amount of goods and services one unit of money can buy and is the reciprocal of the price level of the commodities (goods and services) traded in the economy. It equals 1/P where P is the price level in the economy. The real value of money is what we usually mean when we use the term ‘the value of money’. The real value of M 1 equals M1/P and the real value of M 2 equals M2/P , where P

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  Monetary Economics in Developing Countries

  • Subrata Ghatak, José R. Sánchez-Fung(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  6.4 Specifying money demand functions ..................................................................................... The standard theory of the demand for money has been tested empirically by estim-ating the following equation (for example, Meltzer, 1963; Goldfeld, 1973; Lucas, 1988; Ball, 2001): M D = f P Y R (6.21) where M D is expected to be a ‘stable’ function of a small number of key macroeconomic variables; P , the price level; Y , which is a scale variable (income); and R , a vector of interest rates, representing the opportunity cost of holding money. Price homogeneity is frequently imposed, which is a testable restriction, on the grounds that the units of a currency are irrelevant. So Equation (6.21) becomes M D P = f Y R (6.22) ................................................................. 90 Monetary economics in developing countries Taking logarithms of Equation (6.22) yields (hereafter lower-case letters, represent logs of variables): m − p = 1 y + 2 R (6.23) Equation (6.23) assumes log-linearity in money, prices and incomes, and linearity in interest rates, which is a common functional form. Theoretically, the income elasticity 1 is, for example, 0.5 in the Baumol (1952) and Tobin (1956) transactions demand theory, and 1 in Friedman’s (1956) version of the quantity theory. The components of 2 are semi-elasticities for interest rates. The empirical literature on the demand for money in developing countries frequently highlights a number of factors. Among such factors are the existence of non-monetary transactions (an issue that pertains to the scale variable to be included in the function), and the nature of the interest rate or opportunity cost variable. The former has not being paid much attention in the literature, clearly because of the conceptual, as well as the empirical, difficulties surrounding it.

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