For example if the dollar bill is spent three times

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Unformatted text preview: over” during the year. For example, if the dollar bill is spent three times in a year, it is used for $3 worth of spending. By analogy, aggregate spending in the economy as a whole during a year is equal to the nominal quantity of money in the economy, M, multiplied by the number of times the average unit of money is spent—the velocity of money, V. And nominal GDP, P × Y, is equal to aggregate spending. One way to think about the velocity approach is that it is a special case of the real money demand curve. To see that, let’s rewrite the velocity equation, putting the real quantity of money on the left-hand side: (14-5) M l = ×Y P V Equation 14-5 says that the real demand for money, M/P, is proportional to real GDP, Y, where the constant of proportionality is 1/V. But real GDP is, in equilibrium, equal to real aggregate spending. And we already know that the real quantity of money demanded depends positively on real aggregate spending. UNCORRECTED Preliminary Edition M O N E TA R Y P O L I C Y CHAPTER 14 349 Equation 14-5 says that, more than being positive, the relationship is also proportional. This is why we noted earlier that some economists believe that the real quantity of money demanded is proportional to real aggregate spending. If this is indeed true, then the effect of changes in the interest rate on real money demand is reflected in changes in the velocity of money, V. For example, a rise in the interest rate, which reduces real money demand, will lead to a fall in 1/V—or a rise in V—other things equal. Intuitively, a smaller amount of real money holdings, M/P, will now account for the same amount of real aggregate spending, Y, because velocity has increased. We won’t pursue the velocity approach to money demand any further in this chapter. As we’ll see in Chapter 17, however, the concept of monetary velocity has played an important role in some debates about macroeconomic policy. economics in action Japan, say financial experts, is still a “cash society.” Visitors from the United States or Europe are surprised at how little use the Japanese make of credit cards and how much cash they carry around in their wallets. Yet Japan is an economically and technologically advanced country and, according to some measures, ahead of the United States in the use of telecommunications and information technology. So why do the citizens of this economic powerhouse still do business the way Americans and Europeans did a generation ago? The answer highlights the factors affecting the demand for money. Whatever they are shopping for, Japanese consumers tend to One reason the Japanese use pay with cash rather than plastic. cash so much is that their institutions never made the switch to heavy reliance on plastic. For complex reasons, Japan’s retail sector is still dominated by small mom-and-pop stores, which are reluctant to invest in credit card technology. Japan’s banks have also been slow about pushing transaction technology; visitors are often surprised to find that ATMs close ear...
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