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lectures_2

# lectures_2 - 2 Money Demand This section is concerned with...

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2 Money Demand This section is concerned with the determination of money demand. In the quan- tity theory, we assumed that velocity V is a ﬁxed number. In the data, this as- sumption is not generally satisﬁed; in particular, velocity appears to vary sys- tematically with inﬂation. To address this observation, we develop a theory of money demand and use it to infer the relationship between the velocity of money and inﬂation. Let T be the amount of time (in fractions of a year) between a consumer’s trips to the bank to get money. If T is 1/3, then the consumer goes to the bank every 4 months, or three times a year. For arbitrary T , the consumer makes 1 /T trips to the bank in a year. Going to the bank is a pain. It takes time and effort, and the bank may charge for each withdrawal. We accumulate all such expenses into some cost γ . We could derive γ by: (i) calculating the consumer’s opportunity cost of time; (ii) multi- plying that by the amount of time required to go to the bank; and (iii) adding any fees charged by the bank. γ is measured in units of consumption, so that the dollar cost of a trip to the bank is given by . The cost per year of this consumer’s trips to the bank is just the number of trips times the cost per trip, so the consumer’s annual transactions costs are: (1 /T )( ) . Now, going to the bank is costly, but the consumer still does it because

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lectures_2 - 2 Money Demand This section is concerned with...

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