Download Demand_and_supply_Money

The Demand and
Supply of Money
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Sm
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Dm
$$ demanded
Supply of Money:
Amount of money in circulation is
constantly changing. The amount
depends on how much money is desired
by individuals and businesses.
Supply of money automatically
expands and contracts with the needs
of business.
What is our
Money Supply?
Typically, what the FED
calls M1 money
M1 Money
• Currency (held outside of banks)
• Demand Deposits
• Traveler’s checks
• Other checkable deposits
– Money Market Funds
M1 Money
√ Currency
1. Coin about 2-3% of total M1 for
convenience money; often called token
money because intrinsic value is less than
the face value.
2. Paper money is 46% of total M1
in the form of Federal Reserve Notes
NOTE: M1 excludes currency held in the
bank vault or deposited in Federal
Reserve Banks or held by US Treasury
M1 Money
√ Checkable Deposits
Checks are 52% of total M1, used for
90% of transactions (offered by commercial
banks, thrift institutions, and credit unions);
called demand deposits, Automatic Transfer
Service and Share Draft Accounts.
NOTE: Currency and checkable deposits
owned by the US Treasury, the FED,
commercial banks and other financial
institutions are not counted as M1.
M2 and M3 Money Supply
Near Monies… highly liquid
financial assets that do not directly
function as medium of exchange
but can be easily converted into
currency or checkable deposits.
Importance of Near Monies
1) Spending habits: the greater the
amount of financial wealth held as near
money, the greater the willingness to
spend out of current income
2) Stability: easy conversion from near
money to M1 supply may force inflation
to occur
3) Policy: complicates actions to be
taken.
M2 Money
M1 plus:
savings accounts, money market
mutual funds, money market
deposit accounts, and smalldenomination time deposits
M3 Money
M2 plus:
savings instruments greater
than $100,000.
We do not include less liquid assets
like Treasury Bills and US Savings
Bonds.
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• Large time deposits
+
• Money market accounts
• Savings deposits
• Small time deposits
M3
M2
+
• Checkable deposits
• Travelers checks
• Currency
MI
Does gold or silver
back up our money?
No, our money is not
backed up by anything
Money as Debt
… Paper Money is the circulating
debt of the Federal Reserve Banks.
… Checkable Deposits are the debts
of commercial banks and thrift
institutions.
… Paper Money has no intrinsic
value; it cannot be redeemed in gold
or other “valued” item.
Value of Money
√ Acceptability : confident money is tradable
for goods and services
√ Legal tender: matter of law (creditor must
accept or forfeit right to sue or charge
interest) and government will accept
money in payment of taxes. Checks do not
have this status.
√ Relative scarcity: demand (utility related to
acceptance for goods and services) and supply
(controlled by FED) relationship
Money and Prices
√ Purchasing power of money is the
real value.
√ The amount a dollar will buy
varies inversely with the price level.
D = 1/P
D=Value of the $
P= Price level
Inflation and Acceptability
•Inflation is the result of a society’s spending
beyond its capacity to produce.
•HH & BS are willing to accept currency and
checkable deposits as long as they know it can
be spent without a loss of purchasing power.
•In inflation… the rapid loss of purchasing
power will cause money to lose its function as a
medium of exchange.
•Money will serve its function as a store of
value as long as there is no unreasonable loss in
value by storing it.
Stabilization of Money’s Value
√ Major backing for money is the
government’s ability to keep the value of
money stable.
√ This means appropriate fiscal policy and
wise management of the money supply
through sound monetary policy.
√ In US, a blend of legislation, government
policy, and social practice stops the unwise
expansion of the money supply which could
change money’s value in exchange.
Demand for Money
Transaction demand
• amount of money demanded by individuals and
businesses to buy and sell goods and services
√ Medium of exchange function of money
√ varies directly with GDP
i%
Dt
$$ demanded
Demand for Money
Asset demand
• amount of money demanded by individuals and
businesses to store wealth
√ Store of value function of money
√ varies inversely with GDP
i%
Da
$$ demanded
Demand for Money
Total Demand (Dm)
• Combining the transaction demand and the
asset demand creates the total demand for
money.
• This is the money market and determines the
equilibrium interest rate.
• Shifts in Demand are caused by
•Increases in Price Level
•RGDP
•Financial Technology
Money Demand Curve
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D
D
M1
M2
Q of M
The Money Market
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Supply of money is a
vertical line since
monetary authorities
(FED) and financial
institutions have provided
the economy with a
certain stock of money on
a given day.
Dm
$$ demanded
Quantity Theory of Money
• When RGDP =PGDP, an increase
in the quantity of money bring a
percent increase in the price level.
The Equation of Exchange MV=PY
• (V)elocity = Y(NGDP*Price level)
Quantity of Money (M)
• (P)rice Level = M*V
Y
M= P* Y
V
Inflation & Quantity
Theory of Money
Money Growth + Velocity Growth =Inflation Rate + RGDP Growth