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204A-slides03f - (3f-P.1 Introduction to Money How does...

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(3f)-P.1 Introduction to Money How does money fit into modern macro models ? - Money M = = nominal units issued by the government; p = price level. - Consider discrete periods: Household hold money and interest-bearing assets: c t + a t + 1 + M t + 1 / p t = w t + (1 + r t ) a t + M t / p t - Real rate of return on money holdings = p t / p t + 1 . Purchasing power 1/p. - Money is an inferior store of value whenever p t / p t + 1 < 1 + r t + 1 - Equivalent: Positive interest rate on nominal bonds. => Two branches of monetary theory: a. Monetary models with a “transactions” motive for money - Accept that money is dominated by other assets in terms of return => Assume frictions in exchange processes as motive for holding money b. Monetary theory with money as a store of value: - Most popular: Overlapping-generations models with dynamic inefficiency How important is money for economic activity ? - Even in models with motive for holding money, it may not “matter” economically. - Why should small frictions in exchange have large effects? => Theories why money is important. Most popular: Sticky prices .
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(3f)-P.2 • Motives for holding money : 1. Cash-in-advance constraint (Clower 1967, Lucas 1990) - Implicitly an imperfect information story: Impossible to verify credit at the points of purchase. Need government-issued money to certify purchasing power.
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