White Unit6-Static Monetary Equilibrium

Question 1

Purchasing Power of Money

Answer 1

• Determined by supply and demand

- Clears for money balances

Question 2

In a commodity money economy

Answer 2

• Money stock is endogenous
• Not determined by a central bank
• Supply curve is upward-sloping
• Demand for money commodity includes monetary and industrial demand

Question 3

In a fiat money economy

Answer 3

• Money stock is exogenous
• Determined by a central bank
• Supply curve is vertical
• Demand for money depends on purely monetary demand

Question 4

Inverse relationship between quantity of money that people wants to hold and the purchasing power of dollar

Answer 4

• If purchasing power of dollar goes up, then they. don’t need that much of dollar to purchase.
• For example, Gold: When purchasing power of gold goes up, people desire less gold and substitute others for medium of exchange.

Question 5

Equation of Exchange1

Answer 5

MV=PT

Question 6

Turnover Rate

Answer 6

V=PT/M (Total Transaction/Money Stock)

Turnover rate: How many times average dollars turns in all transaction

Question 7

Equation of Exchange2

Answer 7

MV=Py

Question 8

Income Velocity of Money

Answer 8

V=Py/M (Income Transaction/Money Stock)
Income Velocity of Money: How many times per year, the average dollar turns over in exchange against newly produced goods and services.

Question 9

MV=Py measured in

Answer 9

M=dollars
P=dollars per bundle
y=real dollar(dollars/price)
V=transaction per unit of times per year

Question 10

Consumer Price Index

Answer 10

A measure of the weighted average of prices of a basket of consumer goods and services

Question 11

How can banks make any income?

Answer 11

1) They can earn interest on reserve
2) Have other deposit other than M1 (Loan, Security)
- In other words, if a bank reserve is bigger than checking deposit, then the base is bigger than M1
- Therefore, it is not costly for banks to hold reserves because they can earn interest rates.

Question 12

How banks get rid of excess reserve?

Answer 12

By making loans and creating deposit.
(In recent years, the fact that M0 flat and M1 and M2 had smooth growth means banks are no longer interest in getting rid of excess reserve by creating money)

Question 13

Quantity Theory of Money(Friedman/Schwartz)

Answer 13

• What factors determine the quantity demand of money?
• Change in real demand of money balances tend to proceed gradually.
• But money supply can change at the wishes of central banks
• Therefore, substantial change of prices or nominal income as the result of change in nominal supply of money, independent of money demand.

Question 14

Desired ratio of money balances to income

Answer 14

• (M/Py):determined by real factors, independent of the nominal quantity of money (it is also represented as 1/V)
• Marshall: “k”=(M/Py)
• Fisher: “v”=Py/M

Question 15

Money Neutrality

Answer 15

• The quantity of money can only affect price lever, but not real variables, in the long run.
• However, change in the growth rate of money cannot be neutral because there is a cost of holding money (if holding money does not earn interest rate)

Question 16

M1 and M2 can be endogenous

Answer 16

If the fed has some exogenous target, such as price level.

Question 17

The desire ratio of money balance to income depends on real factors. (What is the logic?)

Answer 17

1) In quantity theory of money, when there is a exogenous change in the quantity of money, it is the price level that will be adjusted.
2) If they get additional dollars, and they have not change preferences for holding dollars, then they will spend off the excess amount of dollars.
3) However, when there is a higher demand of goods and services, prices goes up and therefore, people’s demand for money also goes up.
4) The desire ratio is determined by real factors. Changes in the quantity of money cannot affect the variables.

Question 18

Price-level stability over fixed exchange rates

Answer 18

Marshall: favored uniform world currency, fixed rates.
Fisher: compensated dollar to stabilize p floating rates

Question 19

Proposal for a monetary policy rule

Answer 19

Fisher: modified gold rule to stabilize p
Friedman: rule-bound fiat money

Question 20

Fisher’s modified gold rule

Answer 20

• Define dollar in terms of gold.
• Purchasing power of gold and gold content of dollar are in inverse relationship.
• purchasing power of gold goes up then reduce the gold content of dollar.
• the value of dollar goes up as the quantity of gold has been reduced.

Question 21

Marshall VS Fisher in monetary policy rule

Answer 21

Marshall-the purchasing power of monetary unites depends on the supply of gold.
Fisher-define the dollar in terms of gold to stabilize price

Question 22

Desire to hold money (Yield from money held)

Answer 22

1) Pecuniary: Interest + Increased Purchasing Power Mechanism
2) Non Pecuniary: in-kind services (Convenience)

Question 23

Individual Monetary Equilibrium

Answer 23

Yield from holding non-interest bearing money=the cost of holding it

Question 24

Equilibrium Price Level (Real)

Answer 24

Real money demand curve is vertical: Independent of price.

Real Money Supply curve is downward sloping: higher the price, the value of money supply goes down.

Question 25

Equilibrium Price Level (Nominal)

Answer 25

Money demand curve is upward sloping curve: higher the price, higher the money demand Money supply curve is vertical: the supply is independent of price because it is independent of price.

Question 26

If P is too low to clear the market (1/P too high)

Answer 26

- Excess Supply of money balances - Marginal Utility of holding money is lower than Marginal Utility of buying goods and services - People spend off excess

Question 27

If P is too high to clear the market (1/P too low)

Answer 27

- Excess demand for money balances | - People spend less and sell more to build up money balances

Question 28

The fundamental proposition fo monetary theory

Answer 28

1) real money adjust to real money demand. Nominal money demand adjust to nominal money supply. Through adjustment of price. 2) Fiat equilibrium m (the real money stock) is determined entirely by on the demand side 3) Fiat money M (the nominal money stock) is determined entirely on the supply side)

Question 29

Hot Potato analogy for nominal M

Answer 29

- Excess nominal money can be passed around, but that doesn't make it disappear. - Monday units will be passed around until they "cool off" i.e. become desired and no longer excess - Spending off excess makes price goes up and real money goes down.

Question 30

What is the effect of money injection on prices and interest rates?

Answer 30

- The effect on price is negligible in the Long Run. The redistribution of wealth from change in M also unlikely has permanent effect on money demand. - Austrians argue that the prices changes as a result of money injection have effect on interest rates, but Friedman denied the effect.

Question 31

The long run aggregate supply curve

Answer 31

- vertical at the natural rate of output. Also known as "full employment output". - Illustrate LR neutrality: The idea that the real output of the economy has natural rate that is independent of price level. - Supply shock shifts the curve

Question 32

Shifting the AD Curve

Answer 32

In the MV=PY, when M or V changes, PY changes. Therefore, the aggregate demand curve shifts as well.