Chapter 19 - ● Transactions motive people want to hold on...

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Quantity theory of (the demand of )money: how nominal value of aggregate income is determined Interest rates have no effect on the demand for money Velocity of money: the average amount of times per year that a dollar is spent buying goods/services v=(P*Y)/M Reasonably constant in the short run Demand for money: quantity of money that people want to hold M d = (1/V) * PY Since (1/V) is a constant, the demand for money is purely a function of income and is not affected by interest rates In the short run, output (Y) remains relatively constant Changes in the money supply lead to proportional changes in the price level (keeping V and Y constant) Δ P = Δ M + Δ V - Δ Y = INFLATION ( π ) Since V is constant, π = Δ P = Δ M - Δ Y In the long run, there is a positive correlation between money supply and inflation rate because aggregate output (Y) is kept relatively constant Quantity theory of money is good for LONG-RUN Keynes Liquidity Preference Theory
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Unformatted text preview: ● Transactions motive: people want to hold on to money because it is a medium of exchange ○ HOWEVER, as payment technology advances (credit cards, electronic payments, etc.) the demand for money will decrease relative to income ● Precautionary motive: hold onto money in case of unexpected occurrences ○ This amount of money would be proportional to income ● Speculative motive: hold onto money as a store of wealth ○ HOWEVER, since money earns no interest, as the interest rate rises, the opportunity cost of holding money goes up, and the demand for money will decline ● (M d / P) = L(i,Y) → liquidity preference function ○ The demand for REAL money balances is negatively correlated with interest rates and positive correlated to income ● Implies that velocity is NOT a constant ○ V = (Y* P / M s ) = Y / L(i,Y) ○ As interest rates increase, L(i,Y) decreases which increases velocity...
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