Money (+intro SR) Flashcards
(21 cards)
Functions of money?
Medium of exchange
Unit of account
Store of value
Liquidity
What’s the equation of the money supply? Are debit cards and cheques money supply?
M = C + D
Currency, which is outstanding paper money and coins
Deposits, which are balances in bank accounts depositors can access on demand
No they aren’t! They’re simply a means of transferring money between accounts, they have no impact on the money supply
DEF: reserves
Deposit that banks have received
But haven’t lent out
Is money created under 100% reserve banking? What about fractional reserve banking?
What’s the total money supply’s relation with the reserve deposit ratio and the original deposit?
No, because just transferred from one form eg C into another eg D
Yes, because as prop kept in reserves, the rest lent out, injecting more money into the system. New money BUT ALSO equal amount of new debt.
Total money supply= 1/rr x original deposit
How is bank capital related to leverage?
What’s the leverage ratio and why does it being high imply bad news?
Bank capital is equity of bank owners. Leverage is the use of borrowed funds to supplement existing funds for purposes of investment.
Leverage ratio
= (assets or liabilities) / bank capital
If value assets fall by x%, debt holders and depositors have to be paid first, so the value of owner’s equity falls. If assets
Solution if high leverage ratio?
Capital requirements! Minimum amount of capital mandated by regulators, to ensure banks will be able to pay off depositors
Model of money supply
What are the three assumed exogenous variables?
How do we find M given we know the money supply equation and the money base equation?
1) Monetary base
2) Reserve deposit ratio, rr
3) Currency deposit ratio, cr
Base given by B = C + R
Money supply M = C + D
So… M/B = (C+D)/(C+R) = (cr+1)/(cr + rr)
So M = (cr+1)B/(cr + rr)
(cr+1)/(cr + rr) is the money multiplier, happens when rr<1
How does CB manage monetary base?
1) Refinancing rate - rate at which CB willing to lend to bank SR. Buys assets of bank which agrees to buy back at agreed price.
2) OMO (outright) - buying/selling bonds from public in bond market (usually government securities)
3) Reserve requirements - rr set, influences money multiplier
4) Interest on excess reserves - current accounts for banks in CB to hold their excess reserves
Quantity equation? Explain it
MV = PY
money times the amount it’s changing hands (velocity of circulation) is price times output, which is the value of total output.
This comes from proxy of T because as production rises number of transactions would rise. Stems from V = T/M
Using growth rate rules, what can we predict from the QTM?
MV=PY
Pi = g.m - g.y
We need some money growth to facilitate the increased need for transactions, but any growth beyond that results in inflation.
There’s a one-for-one relation between changes in money growth and changes in the inflation rate
What would money depend on? What is so special about the inflation rate when we sub in i with Fisher eqn?
L(i,Y)
i is the opp cost of holding money, the higher it is the less demand for money we have
Y is income - higher Y, more spending so need more money
The fisher eqn is speshal cuz we have ex ante real interest rate involved, and so nominal is
i= r+pi^e
EXPECTED INFLATION, people don’t know what inflation will be when they wanna hold money or bonds
What happens if you change expected inflation?
Increase inflation expectations, i rises via Fisher, this lowers money demand, which increases prices to make real money balances re-establish equilibrium
What mappers if you change the money supply?
Channel 1:
QTM: we have a rise in money supply, which increases prices one for one
Channel 2:
QTM and Fisher: because we have this increase in money supply, there is a rise in inflation expectations, which increases the nominal interest rate, which reduces real money demand and so prices must rise to equilibrate this
Costs of expected inflation
- Menu costs
- Shoeleather costs
- General inconvenience
- Relative price distortions
- Unfair tax treatment
Costs of unexpected inflation?
Distributional consequences, arbitrary, pensioners might be affected
Uncertainty can affect inter-temporal decisions, people are risk averse
What’s the ONE benefit of inflation?
Allows markets to adjust… nominal wages rarely go down, so can keep those constant and as inflation rises real wages fall and this may help Wr reach LR equilibrium
DEF: seigniorage
What’s the government spending equation?
Revenue the government obtains from printing more money (change in M)
G = T + change in B + change in money supply
Printing more money to finance it’s spending, but this may be considered an inflation tax as it shows by the rise in prices, it’s paid by people holding currency (every other asset is protected due to i rising)
BUT delays in taxation, this falls so real taxes fall, kinda a spiral
DEF : classical dichotomy
The separation of real and nominal variables, nominal has no effect on real
Neutrality of money
Any changes in M DON’T affect real variables
DEF: detrended output
What’s its relationship between actual (Y), potential (Y bar), and the cyclical/short-run fluctuations component?
Detrended output is the difference between actual and potential output, expressed as a percentage of potential output
What is Okun’s Law?
u - ū = -1/2 x Ŷ (ST/detrended output)
For every percentage point that actual output is below potential, the unemployment rate exceeds the natural rate by half a percentage point
