# chapter 12.pdf - AP/ECON2450M(Winter 2017 W.Ho Chapter 12...

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AP/ECON2450M (Winter 2017) W.HoChapter 12: A Monetary Intertemporal Model:Money, Banking, Prices, and Monetary Policy.Outline:What is Money?The Fisher RelationMoney Demand FunctionThe Complete Monetary Intertemporal Model*Labor, Goods, and Money Markets*Competitive Equilibrium*The Neutrality of MoneyThe Short-Run Non-Neutrality of Money*Friedman-Lucas Money Surprise ModelAlternative Money Policy Rules*money growth rate targeting*interest rate targetingThe Zero Lower Bound and Quantitative Easing
AP/ECON2450M (Winter 2017) W.Ho – Notes on Chapter 122What is money?Money has three important functions.1. a medium of exchange2. a store of value3. a unit of accountWhy do we use money in exchange?
AP/ECON2450M (Winter 2017) W.Ho – Notes on Chapter 123Real and Nominal Interest Rates and the Fisher RelationConsider two assets: money and nominal bonds.Money is used as the numeraire (measurementunit).P: the current price level (the current price ofgoods in terms of money).P0: the price level in the future period.A nominal bond is sold for one unit of money inthe current period and will pay1 +Runits ofmoney in the future period.R: the nominal interest rate (in terms of money).r: the real interest rate (in terms of goods).inf: the inflation rate (the growth rate ofP).i=inf=P0-PP.The real interest rate is determined by the Fisherrelation, named after Irving Fisher.1 +r=1 +R1 +inf.
AP/ECON2450M (Winter 2017) W.Ho – Notes on Chapter 124The derivation:Save one unit of current good by purchasingPunits of nominal bonds in the current period.ReceiveP(1 +R)units of money in thenext period and buyP(1+R)/P0units of futuregoods.Gross real interest rate on an asset=total return in units of future goodscurrent goods paid for the asset1 +r=P(1+R)P01=(1+R)P01P=1 +RP0P=1 +R1 +inf.(1 +r)(1 +inf) = (1 +R)r+inf+rinf=Rr=R-inf-rinfrR-infifR