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Unformatted text preview: We’ll start aggregate price level but doesn’t affect ag- by looking at the demand for money by gregate output in the long run. The Demand for Money
In Chapter 13 we saw that M1, the most commonly used definition of the money
supply, consists of currency in circulation (cash) plus checkable bank deposits plus
traveler’s checks. M2, a broader definition of the money supply, consists of M1 plus
deposits that can easily be transferred into checkable deposits. We also saw why people hold money—to make it easier to purchase goods and services. Now we’ll go
deeper, examining what determines how much money individuals and firms want to
hold at any given time. The Opportunity Cost of Holding Money
Individuals and firms hold some of their assets in the form of money because only
money can be used to make purchases directly. But there is a price to be paid for holding money: it normally yields a lower rate of return than nonmonetary assets. For
most individuals and firms, the relevant choice is between money and less liquid assets, such as certificates of deposit, that can be converted fairly quickly into money
but yield higher interest rates than money.
The rate-of-return disadvantage of money is obvious in the case of currency, which
pays no interest. Most checkable bank deposits pay interest, but the rate is lower than
that on other, less convenient assets.
Table 14-1 shows a selection of average interest rates prevailing in two months,
May 2004 and March 2005. The top row shows the federal funds rate. The next row
shows the rate on one-month Treasury bills, a bond issued by the U.S. government
that is paid off in one month. The next row shows the interest rate on zero-maturity
deposits. These are deposits, including checking account deposits, from which funds
can be withdrawn at any time without penalty. The fourth row shows the interest rate
on currency, which is, of course, zero.
TABLE 14-1 Selected Interest Rates
May 2004 March 2005 Federal funds rate 1.00% 2.63% One-month Treasury bill 0.91 2.36 Interest-bearing deposits* 0.54 1.05 Currency 0.00 0.00 Treasury bill rate minus rate on deposits 0.37 1.28 Treasury bill rate minus rate on currency 0.91 2.36 *Average on all zero-maturity deposits, that is, deposits that can be withdrawn at
Source: Federal Reserve Bank of St. Louis. 344 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 Short-term interest rates are the interest
rates on financial assets that mature
within six months or less. Long-term interest rates are interest
rates on financial assets that mature a
number of years in the future. UNCORRECTED Preliminary Edition As you can see, in both months people received a higher rate of interest on onemonth U.S. Treasury bills than they did on either currency or zero-maturity deposits.
There is an opportunity cost to holding money, which we can measure by the difference between the interest rate on assets that aren’t money and the interest rate on assets that are money. The next-to-las...
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- Spring '09
- Monetary Policy