DSST Money & Banking Part 1

Keynes believed that people expect interest rates to

Info icon This preview shows pages 4–6. Sign up to view the full content.

View Full Document Right Arrow Icon
Keynes believed that people  expect interest rates to return to some “normal level” , and depending if rates  were perceived as high or low would determine whether money or bonds was being invested in based on the  belief of where rates were going next. Real Money Balances:  Real Balances = M/P Liquidity Trap Possible:  Whereby the demand for money would become horizontal at a certain interest rate  where everyone believed they could only go up, and thus bond prices could only fall as no one would want to buy  bonds. Keynes main points:  Given people’s expectations about future interest rates and their wealth, the quantity  demanded of money: varies directly with income, varies inversely with current interest rates, varies with the  normal interest rate beliefs of the public, can in principal vary as to produce a liquidity trap that prevents increases  in the supply of money from lowering interest rates, and produces the result that velocity is NOT a constant. Tobin-Baumol Transactions Demand:  Approach implies that the transactions demand for money should vary: inversely  with the degree of synchronization of income and expenditures, inversely with the interest rate, and directly with the  income level of agents. Tobin’s Liquidity Preference Theory (Inventory Theory) : Tobin refined Keynes’ belief of 100% investment in either  money or bonds to state that a rational, wealth maximizing person would instead hold a speculative portfolio Inventory  which combined money and interest bearing assets like bonds.  An increase in interest rates would cause the investor to  move up the money demand curve, holding less money, and an increase in the money demand curve would result in an  increase in income and wealth, or an increase in the perceived riskiness of bonds. Modern Quantity Theory of Money Demand : In the 1950s, Milton Friedman formulated a theory of money demand in a  way similar to the classical quantity theory, but assumed that a large number of factors affect the demand for money than  the classical model suggested. Friedman believed that the demand for money, like the demand for any other asset, is a function of wealth and  the returns of other assets relative to money. 
Image of page 4

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

View Full Document Right Arrow Icon
Demand for money (real balances / assets) varies: inversely with the differences between the returns on other  assets and money, directly with the riskiness of other assets, inversely with the expected rate of inflation, directly  with the permanent income of investors, and directly with ratio of human to nonhuman wealth.
Image of page 5
Image of page 6
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern