Lecture 6 Theories of Money Demand.pptx - MIFI 567 Economic...

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MIFI 567 Lecture 6: Theories of Money Demand AUG 2017 Economic Environment of Finance and Investment Daniel Sakyi [email protected] // 024 370 8390
Introduction 2 Monetary Theory is the study of the effect of money and monetary policy on the economy Demand for Money The desired holding of financial assets or wealth in the form of money i.e. cash/currency/demand deposits It may refer to the demand for either narrow money (M1) or broad money (M2 or M3)
Quantity Theory of Money 3 Developed by the Classical American Economist Irvin Fisher in his famous book the purchasing power of money The quantity theory of money tells us how money is held for a given amount of income - the quantity of money that people want to hold It is a theory of how the nominal value of aggregate income is determined The most important feature of this theory is that it suggests
Quantity Theory of Money 4 Velocity of Money and The Equation of Exchange Fisher wanted to examine the link b/n the total quantity of money (M) and the total amount of spending (total spending) on final goods and services, P*Y M = the money supply P = price level Y = aggregate output (income) P Y aggregate nominal income (nominal GDP) V = velocity of money (average number of times per year that a dollar is spent) V P Y M Equation of Exchange M V P Y
Quantity Theory of Money 5 Velocity fairly constant in short run Aggregate output at full-employment level Changes in money supply affect only the price level Movement in the price level results solely from change in the quantity of money
Quantity Theory of Money 6 Demand for money : To interpret Fisher’s quantity theory in terms of the demand for money… Divide both sides by V When the money market is in equilibrium M = M d Let Because k is fairly constant, the level of transactions generated by a fixed level of PY determines the quantity of M d . In this case the demand for money is not affected by interest rates PY V M 1 V k 1 PY k M d
Quantity Theory of Money 7 From the equation of exchange to the quantity theory of money Fisher’s view that velocity is fairly constant in the short run, so that transforms the equation of exchange into the quantity theory of money, which states that nominal income (spending) is determined solely by movements in the quantity of money M P Y M V
Quantity Theory and the Price Level 8 Because the classical economists (including Fisher) thought that wages and prices were completely flexible, they believed that the level of aggregate output Y produced in the economy during normal times would remain at the full- employment level Dividing both sides by , we can then write the price level as follows: M V P Y Y
Quantity Theory and Inflation 9 Percentage Change in ( x y) = (Percentage Change in x ) + (Percentage change in y ) Using this mathematical fact, we can rewrite the equation of exchange as follows: Subtracting

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