Intermediate Macroeconomics
Lecture 19
Money Supply
100%-reserve banking
Fractional-reserve banking
Money Supply
? A model of money supply
The monetary base,C+R
The reserve-deposit ratio,rr = R/D
The currency-deposit ratio,cr = C/D
Money supply,M = C + D
Monetary base,B = C + R
Money Supply
M/B = (C+D) / (C+R)
M/B = (cr+1) / (cr + rr)
M = [(cr+1) / (cr + rr)]*B
M = m * B
m,the money multiplier
Money Supply
? Money supply depends on
① Monetary base (B),+
② Reserve-deposit ratio (rr),-
③ Currency-deposit ratio (cr),-
Money Supply
? Instruments of monetary policy
① Open-market operation
② Reserve requirement
③ Discount rate
Money Demand
? Portfolio theories of money demand
--- the role as a store of value
--- offers a different combination of risk and return
than other assets (safe/normal return)
The D for M depends on the risk and return offered
by M and by the various assets households can
hold instead of M
Money Demand
? Example,
? Are portfolio theories useful for studying money D?
Depends…
Narrow measures of M ---
Broad measure of M --- plausible
M is a dominated asset
(as a store of value,it exists alongside other assets that are
always better)
),,,()/( WrrLPM ebsd ??
Money Demand
? Transaction theories of money D
--- the role as a medium of exchange
--- best explains why people hold narrow measures
of money
--- although returns are low,benefits of making
transactions more convenient are important
Money Demand
? Baumol-Tobin model of cash management
Money holding over the year
time
M holding M holding
time 1 1
Y
Money Demand
Total cost of trips to the bank,
① Forgone interest,i * (Y/2N)
② Cost of trips,F * N
Money Demand
? Minimize C ?
? Money demand depends on
① Fixed cost for trips to the bank,+
② Expenditure,+
③ i-rate,-
F
iYN
2* ?
i
FYNY
2*2/ ?
Financial Innovation & Near Money
? Near money
---non-monetary assets that have acquired
some of the liquidity of money
---complicates monetary policy by making
money demand unstable
Financial Innovation & Near Money
? Taylor’s Rule & Allen Greenspan
Nominal i-rate of federal funds
= 2 + 0.5*(inflation rate – 2) – 0.5*(GDP*-GDP)
Advances in Business Cycle Model
? The theory of real business cycles
The economics of Robinson Crusoe
--- fluctuations in Y,u,C,I,and productivity are all
the natural and desirable response of an individual
to the inevitable changes in his environment
--- fluctuation has nothing to do with monetary policy,
sticky prices,or any type of market failure
Advances in Business Cycle Model
? All workers perform cost-benefit analysis
when deciding whether to work or to enjoy
leisure,
? The inter-temporal substitution of labor
explains why employment and output
fluctuate,
Advances in Business Cycle Model
? The importance of technology shocks
Technology determines the ability to turn
inputs into outputs,Therefore,the economy
experiences fluctuations in technology and
that these fluctuations in technology cause
fluctuations in output and employment
Advances in Business Cycle Model
? The neutrality of money
---money,not only in the LR,but also in the
SR,is neutral
---money supply is endogenous (Y↑?MS↑)
Advances in Business Cycle Model
? The flexibility of wages and prices
--- wages and prices adjust quickly to clear
markets
What We Know?
1,In the LR,a country’s capacity to produce
goods and services determines the
standard of living of its citizens
2,In the SR,AD influences the amount of
goods and services that a country
produces
What We Know?
3,In the LR,the rate of M growth determines
the inflation rate,but it does not affect the
unemployment rate
4,In the SR,policymakers who control
monetary and fiscal policy face a tradeoff
between inflation and unemployment
What We Don’t?
1,How should policymakers try to raise the
economy’s natural rate of output?
2,Should policymakers try to stabilize the economy?
3,How costly is inflation,and how costly is
reducing it?
4,How big a problem is government debt?
Conclusion
“If all economists were laid end to end,they would
not reach a conclusion.”
--- George Bernard Shaw
“The theory of economics does not furnish a body of
settled conclusions immediately applicable to
policy,It is a method rather than a doctrine,an
apparatus of the mind,which helps its possessor
to draw correct conclusions.”
--- John Maynard Keynes
Lecture 19
Money Supply
100%-reserve banking
Fractional-reserve banking
Money Supply
? A model of money supply
The monetary base,C+R
The reserve-deposit ratio,rr = R/D
The currency-deposit ratio,cr = C/D
Money supply,M = C + D
Monetary base,B = C + R
Money Supply
M/B = (C+D) / (C+R)
M/B = (cr+1) / (cr + rr)
M = [(cr+1) / (cr + rr)]*B
M = m * B
m,the money multiplier
Money Supply
? Money supply depends on
① Monetary base (B),+
② Reserve-deposit ratio (rr),-
③ Currency-deposit ratio (cr),-
Money Supply
? Instruments of monetary policy
① Open-market operation
② Reserve requirement
③ Discount rate
Money Demand
? Portfolio theories of money demand
--- the role as a store of value
--- offers a different combination of risk and return
than other assets (safe/normal return)
The D for M depends on the risk and return offered
by M and by the various assets households can
hold instead of M
Money Demand
? Example,
? Are portfolio theories useful for studying money D?
Depends…
Narrow measures of M ---
Broad measure of M --- plausible
M is a dominated asset
(as a store of value,it exists alongside other assets that are
always better)
),,,()/( WrrLPM ebsd ??
Money Demand
? Transaction theories of money D
--- the role as a medium of exchange
--- best explains why people hold narrow measures
of money
--- although returns are low,benefits of making
transactions more convenient are important
Money Demand
? Baumol-Tobin model of cash management
Money holding over the year
time
M holding M holding
time 1 1
Y
Money Demand
Total cost of trips to the bank,
① Forgone interest,i * (Y/2N)
② Cost of trips,F * N
Money Demand
? Minimize C ?
? Money demand depends on
① Fixed cost for trips to the bank,+
② Expenditure,+
③ i-rate,-
F
iYN
2* ?
i
FYNY
2*2/ ?
Financial Innovation & Near Money
? Near money
---non-monetary assets that have acquired
some of the liquidity of money
---complicates monetary policy by making
money demand unstable
Financial Innovation & Near Money
? Taylor’s Rule & Allen Greenspan
Nominal i-rate of federal funds
= 2 + 0.5*(inflation rate – 2) – 0.5*(GDP*-GDP)
Advances in Business Cycle Model
? The theory of real business cycles
The economics of Robinson Crusoe
--- fluctuations in Y,u,C,I,and productivity are all
the natural and desirable response of an individual
to the inevitable changes in his environment
--- fluctuation has nothing to do with monetary policy,
sticky prices,or any type of market failure
Advances in Business Cycle Model
? All workers perform cost-benefit analysis
when deciding whether to work or to enjoy
leisure,
? The inter-temporal substitution of labor
explains why employment and output
fluctuate,
Advances in Business Cycle Model
? The importance of technology shocks
Technology determines the ability to turn
inputs into outputs,Therefore,the economy
experiences fluctuations in technology and
that these fluctuations in technology cause
fluctuations in output and employment
Advances in Business Cycle Model
? The neutrality of money
---money,not only in the LR,but also in the
SR,is neutral
---money supply is endogenous (Y↑?MS↑)
Advances in Business Cycle Model
? The flexibility of wages and prices
--- wages and prices adjust quickly to clear
markets
What We Know?
1,In the LR,a country’s capacity to produce
goods and services determines the
standard of living of its citizens
2,In the SR,AD influences the amount of
goods and services that a country
produces
What We Know?
3,In the LR,the rate of M growth determines
the inflation rate,but it does not affect the
unemployment rate
4,In the SR,policymakers who control
monetary and fiscal policy face a tradeoff
between inflation and unemployment
What We Don’t?
1,How should policymakers try to raise the
economy’s natural rate of output?
2,Should policymakers try to stabilize the economy?
3,How costly is inflation,and how costly is
reducing it?
4,How big a problem is government debt?
Conclusion
“If all economists were laid end to end,they would
not reach a conclusion.”
--- George Bernard Shaw
“The theory of economics does not furnish a body of
settled conclusions immediately applicable to
policy,It is a method rather than a doctrine,an
apparatus of the mind,which helps its possessor
to draw correct conclusions.”
--- John Maynard Keynes
