The economics of Money, Banking and Financial Markets Part 10 pptx

Par t VI Monetary Theory [...]... expectation of the variable inside the parentheses Var ϭ variance of the variable inside the parentheses If A is the fraction of the portfolio put into bonds (0 ≤ A ≤ 1) and 1 Ϫ A is the fraction of the portfolio held as money, the return R on the portfolio can be written as: R ϭ ARB ϩ (1 Ϫ A)(0) ϭ ARB ϭ A(i ϩ g) Then the mean and variance of the return on the portfolio, denoted respectively as ␮ and ␴2,... a quantity theory conclusion that money is the primary determinant of aggregate spending Empirical Evidence on the Demand for Money As we have seen, the alternative theories of the demand for money can have very different implications for our view of the role of money in the economy Which of these theories is an accurate description of the real world is an important question, and it is the reason why... why evidence on the demand for money has been at the center of many debates on the effects of monetary policy on aggregate economic activity Here we examine the empirical evidence on the two primary issues that distinguish the different theories of money demand and affect their conclusions about whether the quantity of money is the primary determinant of aggregate spending: Is the demand for money sensitive... developed a theory of the demand for money in a famous article, The Quantity Theory of Money: A Restatement.”12 Although Friedman frequently refers to Irving Fisher and the quantity theory, his analysis of the demand for money is actually closer to that of Keynes than it is to Fisher’s 12 Milton Friedman, The Quantity Theory of Money: A Restatement,” in Studies in the Quantity Theory of Money, ed Milton... result of this evidence, the M1 money demand function became the conventional money demand function used by economists The Case of the Missing Money The stability of the demand for money, then, was a well-established fact when, starting in 1974, the conventional M1 money demand function began to severely overpredict the demand for money Stephen Goldfeld labeled this phenomenon of instability in the demand... transactions-based theory of the demand for money in which the demand for real balances is proportional to real income and is insensitive to interest-rate movements An implication of his theory is that velocity, the rate of turnover of money, is constant This generates the quantity theory of money, which implies that aggregate spending is determined solely by movements in the quantity of money 2 The classical... to the transactions and precautionary components of money demand as well as to the speculative component 5 Milton Friedman’s theory of money demand used a similar approach to that of Keynes Treating money like any other asset, Friedman used the theory of asset demand to derive a demand for money that is a function of the expected returns on other assets relative to the expected return on money and. .. Tobin, The Interest Elasticity of the Transactions Demand for Cash,” Review of Economics and Statistics 38 (1956): 241–247 526 PART VI Monetary Theory month with $500 of cash, and by the middle of the month, his cash balance has run down to zero Because bonds cannot be used directly to carry out transactions, Grant must sell them and turn them into cash so that he can carry out the rest of the month’s... is unchanged, the Equation 2 line in the bottom half of the figure does not change However, the slope of the opportunity locus does increase as i increases Thus the opportunity locus rotates up and we move to point C at the tangency of the new opportunity locus and the indifference curve As you can see, the optimal level of risk increases from ␴ * and ␴ * the optimal 1 2 fraction of the portfolio in... exhausted by the end of the month In panel (b), half of the monthly payment is put into cash and the other half into bonds At the middle of the month, cash balances reach zero and bonds must be sold to bring balances up to $500 By the end of the month, cash balances again dwindle to zero 7 William J Baumol, The Transactions Demand for Cash: An Inventory Theoretic Approach,” Quarterly Journal of Economics . influence the demand for any asset. Friedman then applied the the- ory of asset demand to money. The theory of asset demand (Chapter 5) indicates that the demand for money should be a function of the. another essential part of monetary theory is the demand for money. This chapter describes how the theories of the demand for money have evolved. We begin with the classical theories refined at the. explore the role of the money supply in determining the price level and total production of goods and services (aggregate output) in the economy. The study of the effect of money on the economy