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1、Chapter Eight Money Demand&Money Supply,Sketch of Chapter Eight,Some concepts of money demand,.,.,Money demand,Implication of money demand,Factors determining money demand,Theories of money demand,Marxs theory of money demand,Classical theories of Md,Modern quantity theory of Md or Monetarists theor
2、y,Traditional quantity theories of Md,Keynesian theory of Md,Fishers equation,Cambridge approach,Velocity and missing of money,Missing of money,Causes of decreasing velocity of money,Money supply,Some concepts of money supply,Mechanism of money supply,Money creation by commercial banks,Money creatio
3、n by the central bank,Commercial banks deposit derivation and contraction,Leakages of commercial banks money creation,Ration of cash leakages,Ratio of excess reserves,Ration of leakage into noncheckable deposits,Monetary base,Monetary base&money multiplier,Factors affecting monetary base&money multi
4、plier,S.1.Money Demand 1.1.Implication of money demand 1,Some concepts of money demand,1)Money demand:Money demand refers to the quantity of money that the whole economy needs as medium of exchange,means of payment and store of value under certain economic condition.Desire resulting from the choice
5、of interest cost,anticipated income Md Capacity being subject to the disposable income and wealth held 2)Nominal and real money demand Nominal money demand refers to peoples demand for money at the current price level while real money demand refers to peoples real demand for money corrected for the
6、expected inflation.Md represents nominal money demand Md represents real money demand P,S.1.Money Demand 1.1.Implication of money demand 1,Some concepts of money demand,3)Macro and micro money demand Micro money demand makes a study on how much money micro-entities should hold to obtain the maximum
7、profit at lowest opportunity cost given the income level,interest rate level and other economic conditions.Macro money demand discusses the necessary quantity of money a nation should have in its economic growth and circulation of commodities and production during a certain period.,S.1.Money Demand
8、1.1.Implication of money demand 2.Factors determining money demand.,1)The level of interest rates and financing conditions.2)Yields and investment environment.3)Expectation of inflation and price level.4)Income level and techniques of finance management.5)The velocity of money.6)The efficiency of fi
9、nancial markets and transaction costs.,S.1.Money Demand 1.2.Theories of money demand 1,Marxs theory of money demand,Quantity of money in the total amount of price circulation=the velocity of money PQ M=V PQ,M;or P,M V,M,S.1.Money Demand 1.2.Theories of money demand 2.Classical quantity theories of m
10、oney demand,1)Fishers Equation of Exchange(1)MV=PT M,P or M,P M:the quantity of money in circulation.V:the transaction velocity of money,I.e.the number of times the average unit of money is spent per year.P:the average price of the transactions that take place during the year.T:the total level of tr
11、ansaction during the year.,S.1.Money Demand 1.2.Theories of money demand 2.Classical quantity theories of money demand,(2)MV=PY V:the income velocity of money or the number of times the average unit of money is spent on final goods and services per year.P:the average price of all final goods and ser
12、vices purchased during a year.Y:the total output of goods and services.M=PY=1 PY V V 1 Substituting Md for M,K for V Md=K x Py,S.1.Money Demand 1.2.Theories of money demand 2,Classical theories of money demand,2)Cambridge cash-balance approach Md=kY P:price level;Y:total income=Py K:the ratio of wea
13、lth in nominal GDP.Its affected by a few factors,such as interest rates,inflation rates,etc.Md:the nominal demand for money.Md equals the supply of money if the economy is in equilibrium.,S.1.Money Demand 1.2.Theories of money demand 2,Classical quantity theories of money demand.,3)The difference be
14、tween the two classical theories(1)Each of the two equations has paid particular attention to the different functions of money.The former stresses the medium of exchange function of money.;the latter focuses on the function of money as store of value.(2)The two equations analyze money demand form di
15、fferent perspectives.Fishers equation studies money demand from the macro perspective while Cambridge school studies on the micro basis which is determined by such factors as interest rates,inflation rates,ect.(3)The two equations stress different factors determining money demand.Fishers equation ex
16、plains price level with change of quantity of money demand.Conversely,money demand can be obtained with given velocity of money when total transactions and price level given.Cambridge approach regards money as an asset,income of non-money assets as the opportunity cost of holding money.So Cambridge
17、school initiated the study of money demand from the perspective of asset choosing for individual.,S.1.Money Demand 1.2.Classical theories of money demand 2,Keynesian theory of money demand,1)Keynes theory of money demand transaction demand I Md precautionary demand I Md speculative demand r Md Keyne
18、sian function of money demand M=M1+M2=L1(Y)+L2(r)M1:transaction demand and precautionary demand for money and is the function of income(Y);M2:speculative demand for money and is the function of the interest rate(r).L1 and L2:the function of“liquidity preference“,S.1.Money Demand 1.2.Classical theori
19、es of money demand 2,Keynesian theory of money demand,2)Development of theory of money demand made by keynesian school(1)Keyness successors held that interest rate and transaction cost are also factors affecting transaction demand money.(2)Precautionary demand for money has negative relationship wit
20、h the interest rate.(3)Keynesian school advanced Keyness theory of the speculative demand for money and raised the theory of asset portfolio.M=L1(r,Y)+L2(I),S.1.Money Demand 1.2.Classical theories of money demand 2,Keynesian theory of money demand 2)Development of theory of money demand,James Tobin
21、raised portfolio theory to explain how people choose assets under uncertainty and showed that most people prefer to have a balanced portfolio with several types of assets.When marginal utility of income=negative utility of risk,the equilibrium point of holding both money and bonds will be reached,wh
22、ich means the optimum asset portfolio.,S.1.Money Demand 1.2.Classical theories of money demand 2,Keynesian theory of money demand 2)Development of theory of money demand,Substitution effect:With substitution effect people would like to hold more non-money assets in order to have higher return which
23、will lead to the decrease of money demand when the interest rate rise Income effect:The change of interest rates affects peoples interest income as the ups and downs of interest rates increase or decrease peoples interest income.,S.1.Money Demand 1.2.Classical theories of money demand 3.Modern quant
24、ity theory of money demand,Md/P=f(Yp,Rm,Rb,Re,P,W,U)Md/P:the demand for real money balance.Yp:real GDP,the index used to count wealth,called permanent income.Rm:expected rate of return for money.Rb:expected rate of return for bonds.Re:expected rate of return for stocks.P:expected rate of return of g
25、oods or expected rate of inflation.W:the ratio of human wealth to non-human wealth.U:other random variables,including preference,custom,technology,system,etc.,S.2.Money Supply 2.1.Some concepts of money supply,1,Money stock and money flow 2,Nominal and real money supply 3,Exogeneity and endogeneity
26、of money supply,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks,1)The preconditions for money creation by commercial banks:(1)Fractional reserve system(2)Non-cash settlement,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial bank
27、s,2)The relationship among reserves Primary deposits refer to the deposits that commercial banks take in and that increase commercial banks reserves Derivative deposits refer the deposits derived when commercial banks make loans and take in deposits through non-cash settlement.The quantity relations
28、hip among reserves reserves=required reserve+excess reserve=vault cash+commercial banks deposits with the central bank excess reserve=reserves required reserve,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks 3)Commercial banks deposit derivation,S.2.Money Supp
29、ly 2.2.The mechanism of money supply 1,Money creation by commercial banks 3)Commercial banks deposit derivation,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks 3)Commercial banks deposit derivation,S.2.Money Supply 2.2.The mechanism of money supply 1,Money cre
30、ation by commercial banks 3)Commercial banks deposit derivation,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks,Money creation appears as follows:100000 x(1-20%)=$80000 80000 x(1-20%)=$64000 64000 x(1-20%)=$51200 So derivative deposit is:80000+64000+51200+0=$4
31、00000 Total deposit is:100000+400000=$500000,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks 3)Commercial banks deposit derivation,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks,Money multiplier:Money multiplier is the
32、multiple of contraction and expansion of monetary base:K=1/Rd Monetary base B=C+R C R C D Money supply M1=C+D,K=C+D/C+R=M1/B,From M1=B x K K=M1/B,S.2.Money Supply 2.2.The mechanism of money supply 1,Money creation by commercial banks,4)The leakage in the process of commercial banks money creation(1)
33、Deposit money multiplier A,The ratio of cash leakage into currency held by the nonbank public.K=1/(Rd+c)c stands for the ration of cash held by the public to deposits B,The ratio of excess reserve on a voluntary basis K=1/(Rd+c+e)e stands for the ratio of excess reserve held by banks,S.2.Money Suppl
34、y 2.2.The mechanism of money supply 2,Money supply under the central bank,C,The ratio of leakage into noncheckable deposits K=1/(Rd+c+e+Dn x Rn)Dn for the ratio of leakage into noncheckable deposits;Rn for the required reserve ratio for noncheckable deposits.(2)M1 and M2 money multiplier M1 K=c+1/(R
35、d+c+e+Dn.Rn)M2 K=1+c+t/(Rd+c+e+Dn.Rn),S.2.Money Supply 2.2.The mechanism of money supply 2,Money supply under the central bank,1)Monetary base or high-power money B=C+R(1)Monetary base&money creation by commercial banks:the source and the flow(2)Monetary base and money multiplier B x k=M1,S.2.Money
36、Supply 2.2.The mechanism of money supply 2,Money supply under the central bank,2)Factors affecting monetary base Monetary base=the central banks assets other non-money liabilities and net worth(L1+L2)=(A1+A2+A3+A4)(L3+L4)(1)L3L4-,(A1,A2,A3,A4),B(2)(A1,A2,A3,A4)-,L3L4 B,S.2.Money Supply 2.2.The mecha
37、nism of money supply 2,Money supply under the central bank,As central banks liabilities,monetary base is corresponding with each of central banks assets 1)The state of international finance The size of central banks purchase of foreign exchange will determine that of monetary base.2)Central banks mo
38、netary policy Central banks expansion of discount or lending to commercial banks and open market operation will increase monetary base or vise versa.3)Government spending Government spending will increases commercial banks deposits,further increase commercial banks reserves with the central bank.So
39、monetary base will increase.,S.2.Money Supply 2.2.The mechanism of money supply 2,Money supply under the central bank,3)Factors affecting the money multiplier(1)Required reserve ratio(2)Excess reserve commercial banks hold(3)The level of cash leakage(4)The level of leakage into noncheckable deposits
40、,Factors affecting money supply,Money supply,Monetary base,Money multiplier,Balance of payment,Monetary policy,Government spending,Required reserve ratio,Excess reserve,Currency ratio,Leakage into noncheckable deposits,S.2.Money Supply S.2.Money Supply 2.2.The mechanism of money supply and revenue a
41、nd expenditure,1.The change of R.and E.affects the central banks assets and liabilities,further money supply.2.The change of R.and E.induce the change of commercial assets and liabilities,further money supply.3.R commercial banks M central bank contraction of Ms E central bank M commercial banks exp
42、ansion of Ms,Summary,1,Money demand refers to the need that people are willing to hold their income and assets in the form of money.Money demand is determined by a number of factors.2,From the Mercantilist time many economists began to study the demand for money and raised various theories.Each theo
43、retic school has its respective features and limitations of time.3,Money supply refers to the whole process in which money is put into circulation,created in a nations economy.4,The process of money creation involves the central bank,commercial banks,depositors and borrowers,but among them the most
44、important are the central bank and commercial banks.The former has the privilege to provide monetary base and regulate money supply while the latter create money.5,There are two factors that determine money supply:1)Monetary base which depends on the central banks behavior;2)the money multiplier whi
45、ch is further determined by the required reserve ratio,the ratio of cash leakage and the leakage into the noncheckable deposits resting with the behavior of money holding of businesses and households and the excess reserve on voluntary base.,Review questions,Key terms Fishers equation of exchange Cambridge cash-balance approach Exogeneity of money supply Endogeneity of money supply Excess reserve Derivative reserve Primary reserve Money multiplier ratio of cash leakage currency ratio Ratio of leakage into the non-checkable deposits Monetary base,
