C48 MT 08S A - ECM C48 Midterm SOLUTIONS Question 1(10...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
ECM C48 Midterm - SOLUTIONS Question 1. (10 Marks) Inside money is defined to be the sum of all financial assets created inside the private financial sector. This is the sum of all bank loans, bank deposits, corporate stock, corporate bonds etc. - represent or create net wealth for the private sector . Outside money is the sum of all financial assets created outside of the private financial sector (i.e. by the government or public sector). This is all government created currency (cash) plus government bonds. - Since these assets are held by the private sector (as credits) while the liabilities (for them) are held by the public sector then outside money equals the net wealth of the private sector . Quantity Theory of Money (QTM) postulates that in long-run and beyond the quantity of (nominal) money supplied (M) determines the size and growth rates of other aggregate nominal variables such as gdp, the dgp deflator, the inflation rate, the nominal interest rate etc. This theory uses the so-called quantity equation, MV=PY, where M is nominal money supply, P is the gdp deflator, V is the velocity of money, and Y is real gdp. The inside/outside theory of money takes the two observations above (i.e. the two bullet points above) together with the assumption that private sector welfare depends (solely) on the level of net private sector wealth. This implies that only outside money affects the level of welfare of the private sector. - These definitions and their related theory are inconsistent with what we know about the Quantity Theory of Money. In the long-run and beyond we know that real gdp is determined by real factors (i.e. due to the classical dichotomy or neutrality of money). Further the velocity of money is fixed in long-run equilibrium as well so increases in the nominal money supply (M) simply result in an equal proportionate increase in the nominal price level (P). Thus the real money supply (M/P) does not change so the central bank does not have the ability to change real wealth in the long-run (and beyond). Therefore changes in outside money (via changes in government issued cash) do not result in Question 2. (15 Marks) Operational efficiency relates to how well the financial system undertakes the function of transferring funds from lenders to borrowers (operational costs). If banks are highly competitive the costs associated with this function should be small. Operational efficiency is impacted by (de)regulation, market structure (concentration & mergers), globalization, competition, technology (changes). As explained in the diagram below, operational efficiency is measured in terms of the welfare impact
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 8

C48 MT 08S A - ECM C48 Midterm SOLUTIONS Question 1(10...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online