The Economics of Money, Banking, and Financial Markets - Chapter 20

Flashcards on the Quantity Theory of Money and Demand for Money

Velocity of Money

Average number of times per year that a dollar is spent.

Equation of Exchange

M x V = P x Y. M = money supply, V = velocity of money, P = price level, Y = aggregate output (income)

Quantity Theory of Money

Changes in money supply affect only the price level because aggregate output is at full employment level and velocity is constant in the short run.

Demand for Money (Fisher's Quantity Theory)

M = k x PY, where k is constant, PY is nominal income and M is money supply.

Quantity Theory of Money

Nominal income (spending) is determined solely by movements in the quantity of money because velocity is fairly constant in the short run.

Inflation Rate (Quantity Theory)

Percentage Change in Money Supply - Percentage Change in Aggregate Output

Budget Deficits and Inflation

When the government creates money and uses it to pay for goods and services it buys.

Hyperinflation

Periods of extremely high inflation of more than 50% per month.

Keynes's Three Motives for Holding Money

Transactions, Precautionary, and Speculative

Transactions Motive

Individuals hold money to conduct transactions.

Precautionary Motive

Individuals hold money as a cushion against unexpected wants.

Speculative Motive

Individuals hold money as a store of wealth.

Velocity and Interest Rates

The procyclical movement of interest rates should induce procyclical movements in velocity.

Portfolio Choice Theory and Keynesian Liquidity Preference

The demand for real money balances is positively related to income and negatively related to the nominal interest rate.

Other Factors Affecting Money Demand

Wealth, Risk, Liquidity of other assets

Precautionary Demand and Interest Rates

As interest rates rise, the opportunity cost of holding precautionary balances rises.

Interest Rates and Velocity

If interest rates do not affect the demand for money, velocity is more likely to be constant.

Stability of Money Demand

If the money demand function is unstable, then velocity is unpredictable.