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ECON303 Topic 2 - TOPIC 2 Interest rates and exchange rates...

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TOPIC 2 I d h i Interest rates and exchange rates in monetary equilibrium, PPP, real exchange rate determination 1
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What Is Money? Money is an asset that is widely used and accepted as a means of payment. Different groups of assets may be classified as money money. Money is very liquid and pays little or no rate of return . 2
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Money Supply Central banks can influence the money supply by directly regulating the amount of currency in circulation. indirectly controlling the amount of deposits issued by private banks. 3
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Money Demand T he amount of assets that people are willing to hold as money (instead of illiquid assets) depends on: 1. Expected returns/interest rate on money relative to the expected returns on other assets. 2. Risk : the risk of holding money principally comes from d i fl i hi h dl d h unexpected inflation, which unexpectedly reduces the purchasing power of money. but most financial assets have this risk too, so this risk is not very important in money demand 3. Liquidity : A need for greater liquidity occurs when either the price or the quantity of goods bought in transactions increases price or the quantity of goods bought in transactions increases, ie when GNP rises. 4
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A Model of Aggregate Money Demand Th l d d i The aggregate real money demand is: M d /P L ( R Y ) /P = R,Y + where: P is the price level Y is real national income R is interest rate L ( R,Y ) is the aggregate real money demand 5
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