Mishkin PPT Ch19

8/19/2019 Mishkin PPT Ch19

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Copyright © 2010 Pearson Addison-Wesley. All rights reserved.

Chapter 19

The Demandfor Money


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Copyright © 2010 Pearson Addison-Wesley. All rights reserved.18-2

M = the money supply

P = price level

Y = aggregate output (income) P × Ψ = αγγρεγατε νοµ ιναλινχοµ ε (νοµ ιναλΓ∆Π)

ς = ϖελοχιτψ οφµ ονεψ (αϖεραγε νυµ βεροφτιµ εσπερψεαρτηατ α δολλαρισσπεντ)

ς = Π × Ψ

Μ Εθυατιον οφ Εξχηανγε

Μ ×ς = Π × Ψ

Velocity of Money and TheEquation of Exchange


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Quantity Theory

• Velocity fairly constant in short run

• Aggregate output at full-employment level

• Changes in money supply affect only theprice level

• Movement in the price level results solely

from change in the quantity of money


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Quantity Theory of MoneyDemand

Divide both sides by V

When the money market is in equilibrium

M = M d

Let

Because k is constant, the level of transactions generated by a fied level of PY determines the quantity of M d .

!he demand for money is not affected by interest rates

PY V

M ×= 1

V k

"=

PY k M d ×=


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Quantity Theory of MoneyDemand

• Demand for money is determined by:

– he level of transactions generated by the level ofnominal income PY

– he institutions in the economy that affect the!ay people conduct transactions and thusdetermine velocity and hence k


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FI!"E 1 Change in the Velocity of M"and M# from $ear to $ear% "&"'–#(()

Sources: Economic Report of the President; Banking and Monetary Statistics;

!!!*federalreserve*gov+releases+h,+hist+h,hist"*tt*


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#eyne$%$ &iquidity'reference Theory

• .hy do individuals hold money/

– ransactions motive

– 0recautionary motive

– 1peculative motive

• Distinguishes bet!een real and nominalquantities of money



M d

P = φ (ι,Ψ ) ωηερε τηε δεµ ανδ φορρεαλµ ονεψ βαλανχεσι

νεγατιϖελψ ρελατεδ το τηε ιντερεστ ρατε ι,

ανδ ποσιτιϖελψ ρελατεδ το ρεαλινχοµ ε Ψ

Ρεωριτινγ

Π

Μ δ =

1

φ (ι,Ψ )

Μυλτιπλψ βοτη σιδεσβψΨ ανδ ρεπλαχινγ Μ δ ωιτη Μ

ς = ΠΨ

Μ =

Ψ

φ (ι,Ψ )

The Three Moti(e$



The Three Moti(e$ )cont%d*

• Velocity is not constant:

– he procyclical movement of interest rates shouldinduce procyclical movements in velocity*

– Velocity !ill change as epectations about futurenormal levels of interest rates change


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Further De(elopment$ in the#eyne$ian +pproach

• ransactions demand

– 2aumol - obin model

– here is an opportunity cost and benefit

to holding money– he transaction component of the demand for

money is negatively related to the level ofinterest rates



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FI!"E , Cash 2alances in the2aumol-obin Model



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'recautionary Demand

• 1imilar to transactions demand

• As interest rates rise% the opportunity cost ofholding precautionary balances rises

• he precautionary demand for money isnegatively related to interest rates



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-peculati(e Demand

• 3mplication of no diversification

• 4nly partial eplanations developed further5obin6

– 7is8 averse people !ill diversify its portfolio andhold some money as a store of !ealth

– Do not provide a definite ans!er as to !hy

people hold money as a store of !ealth



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Friedman%$ Modern QuantityTheory of Money

= demand for real money balances

= measure of #ealth (permanent income)

= epected return on money

= epected return on bonds

= epected return on equity (common stocks)

= epected inflation rate

( mememb pd

r r r r r Y f P

M $$$= π ,,,

P

M d

pY

mr

b

r

er

eπ


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Varia.le$ inThe Money Demand Function

• 0ermanent income 5average long-run income6 isstable% the demand for money !ill not fluctuatemuch !ith business cycle movements

• .ealth can be held in bonds% equity and goods9incentives for holding these are represented by theepected return on each of these assets relative tothe epected return on money

• he epected return on money is influenced by:– he services proved by ban8s on deposits

– he interest payment on money balances


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Difference$ .et/een #eyne$%$and Friedman%$ Model

• riedman

– 3ncludes alternative assets to money

– Vie!ed money and goods as substitutes

– he epected return on money is not constant9ho!ever% r b – r m does stay constant as interest

rates rise

– 3nterest rates have little effect on the demand formoney


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Difference$ .et/een #eyne$%$and Friedman%$ Model )cont%d*

• riedman 5cont;d6

– he demand for money is stable ⇒velocity is predictable

– Money is the primary determinant of aggregatespending


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Empirical E(idence

• 3nterest rates and money demand

– Consistent evidence of the interest sensitivity of thedemand for money

– % instability of the money demand function has

caused velocity to be harder to predict

• 3mplications for ho! monetary policy shouldbe conducted

Mishkin PPT Ch19

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