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Unformatted text preview: Chapter 28 The Demand for Money Reasons for holding money • The amount of money that everyone wishes to hold is the demand for money • The opportunity cost of holding money is the interest that could have been earned if the money had been used to purchases bonds. There are 3 reasons for holding money: • The transaction motive – the higher the value of the GDP the higher the transactions demand for holding money • The precautionary motive – you might need a transaction for precautionary reasons • The speculative motive – if you think interest rates are going to rise, that means that you think that bond prices are going to fall in the near future, then you don’t want to be holding bonds right now, therefore holding more money. All these 3 forces are running, but we think of the holding of money as the sum of the 3. The determinants of Money Demand We focus on 3 variables: • Real GDP (+) • The price leve (+) – holding real GDP, the higher the price level, the greater is the dollar value of the GDP, this causes the dollar value of transactions going up – therefore Nominal GDP matters, due to the real GDP and price level. • The interest rate (-) – the nominal interest rate is the opportunity cost of holding money o These are the 3 macro variables that affect the demand for money. • The money demand (Md) curve is sometimes called the liquidity preference function. • For an increase in the interest rate, the quaitity of money decreases • Changes in Y or P causes the shift of the Md curve • Change in i there is a movement alone the Md curve Md=Md(-I,+Y,+P) Monetary equilibrium and national income Monetary Equilibrium Monetary equilibrium occurs when the quantity of money demanded equals the quantity of money supplied equilibrium interest rate • It is vertical as the amount of deposit multiplication with the commercial banking system is independent of the interest rates. •...
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