KRUGMAN_WELLS_MACRO_CHAPTER14

So people limited the number of times they needed to

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Unformatted text preview: ant standing in line. So people limited the number of times they needed to withdraw funds by keeping substantial amounts of cash on hand. Not surprisingly, this tendency diminished greatly with the advent of ATMs in the 1970s. These events illustrate how changes in technology can affect the real demand for money. In general, advances in information technology have tended to reduce the Real quantity of money, M/P 347 348 PA R T 5 S H O R T- R U N E C O N O M I C F L U C T U AT I O N S UNCORRECTED Preliminary Edition real demand for money by making it easier for the public to make purchases without holding significant sums of money. ATM machines are only one example of how changes in technology have altered the demand for money. The ability of stores to process credit card transactions via the Internet has widened the acceptance of credit cards and similarly reduced the need for cash. Changes in Institutions Changes in institutions can increase or decrease the demand for money. For example, until the beginning of the 1980s, U.S. banks weren’t allowed to offer interest on checking accounts. As a result, the opportunity cost of holding funds in checking accounts was very high. That disincentive was greatly reduced when a change in banking regulations made interest on checking accounts legal, leading to a rise in the real demand for money. The Velocity Approach to Money Demand The velocity of money is nominal GDP divided by the nominal quantity of money. We have discussed the demand for money using the same framework we use for discussing any demand curve: first we describe the reasons the curve slopes downward, and then we discuss the factors that shift the curve rightward or leftward. In some discussions about money demand and monetary policy, however, economists use a different approach, emphasizing a concept known as the velocity of money. The velocity of money is defined as nominal GDP divided by the nominal quantity of money. That is, (14-3) V = According to the quantity equation, the nominal quantity of money multiplied by the velocity of money is equal to nominal GDP. P×Y M where V is the velocity of money, P is the aggregate price level, Y is aggregate output measured by real GDP (so that P × Y equals nominal GDP), and M is the nominal quantity of money. This definition is often restated by multiplying both sides of the equation by the quantity of money to yield the quantity equation: (14-4) M × V = P × Y It says that the nominal quantity of money multiplied by the velocity of money is equal to nominal GDP. The intuition behind the concept of velocity is that each unit of money in the economy can be spent several times over the course of a year. For example, someone may use a dollar bill to pay for a cup of coffee at a restaurant; the restaurant may give that dollar bill as change to someone else who buys a sandwich; that person may use the dollar bill to buy a newspaper; and so on. The value of spending that takes place using a particular dollar bill in a given year depends on the number of times that dollar bill “turns...
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