notes_on_money_demand

notes_on_money_demand - Notes on Money Demand The simplest...

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Notes on Money Demand The simplest money demand function is constructed from the quantity equation in which velocity is constant: M t V P t Y t and this states that real money balances are proportional to real income: M t P t Y t where is the inverse of constant velocity. Note that in this model, the price level is affected by either changes in the money supply at date t or by output at date t . Now we consider a model in which velocity exhibits the "hot potato" effect. That is, if consumers expect higher inflation in the future, they will try to get rid of money and thus velocity rises. In this case, velocity depends on expected inflation: V t V t 1 e where t 1 e is expected inflation between today and tomorrow. The simplest model of this process is called the Cagan model of money demand . The model is given by: m t p t p t 1 e p t , or m t p t  t 1 e Here, lower case letters are all the natural logs of the relevant variables
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notes_on_money_demand - Notes on Money Demand The simplest...

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