2. The Demand for Money
• Why would people hold money?
– Transactions Demand for Money
– Precautionary Demand for Money
– Speculative Demand for Money
3. The Demand for Money Curve
• The three motivates for holding money
combine to create a demand for money curve.
– Def: The demand for money curve represents the
money people hold at different possible interest
rates, ceteris paribus.
– Why is it downward sloping?
– Example of Graph
5. The Equilibrium Interest Rate
• The supply of money is a vertical line (MS)
implying that the quantity of money supplied
is independent of the interest rate
– Why?
– Show equilibrium
7. What happens if the Fed increases the
money supply?
• The opportunity cost of holding money falls
enough that the public is willing to hold the
now larger stock of money
8. How the Fed Controls the MS?
• The establishment of reserve requirements for
banks
• Buying and selling U.S. government securities
and other financial assets in the open market
• The volume of loans extended to banks and
other institutions
• The interest rate it pays banks on funds held
as reserves
10. Recent Monetary Policy
• Increase in the monetary base from $828
billion at mid-year 2008 to $1.63 trillion in
early 2009 to more than $2 trillion in 2010.
• Lower interest rates
16. Adding the Short-Run Aggregate
Supply Curve
• For a given shift of the aggregate demand
curve, the steeper the short-run aggregate
supply curve, the smaller the increase in real
GDP and the larger the increase in the price
level.
18. The Monetarist View of the Role of
Money
• Def: Monetarism is the theory that changes in
the money supply directly determine changes
in prices, real GDP, and employment
– They put the spotlight on the money supply. They
argue that to predict the condition of the
economy, you simply look at the money supply.
– Too much money supply = higher inflation
– Too less money supply= unemployment and
deflation
19. The Equation of Exchange
• Def: The equation of exchange is an
accounting identity that state’s the MS time
velocity of money is equal to total spending:
MV=PY
20. The Quantity Theory of Money
• It is assumed by classical economists that V
and Y(real output) are fairly constant.
– Why is this true?
– Def: The Quantity Theory of Money states that
changes in the money supply are directly related
to changes in the affect of price level.
21. Modern Monetarism
• Today, we do not think that V is constant and
the employment does not always operate at
full employment
– M& P are correlated, but not perfectly correlated.
22. Targets Before 1982
• Between World War II and October 1979- the Fed
attempted to stabilize interest rates.
• Friedman said this made monetary policy a
source of instability in the economy because
changes in the money supply reinforced
fluctuations in the economy.
– He said pay less attention to interest rates and instead
focus on a steady and predictable growth in the
money supply
– Monetary rule
23. Targets After 1982
• Less force on a steady and predictable growth
in the money supply.
• The force was on a targeted federal funds rate.