THE COMPLETE “MONEY” MODEL The Inner Loop THE COMPLETE “MONEY” MODEL Rest of the World Banks & Credit Fiscal Policy PrM Spending Exports Investment Government Purchases Consumption LaM FxM CrM TRSY Foreign Capital Budget Deficit Change of Money Demand Change of Money Supply Profit, interest, rent wages Cash The FED (net) Taxes Imports Saving H/B Income Money

ABBREVIATIONS E I PrM H/B X C Y TRSY T G FxM CrM F S K BB/Def ΔMD ΔMS The FED Cash ΔMD ΔMS

Sometimes we will ignore ΔMD and/or ΔMS THE FULL CLOSED MODEL Rest of the World Banks & Credit Fiscal Policy PrM X E I G FxM K CrM BB/Def TRSY C Sometimes we will ignore ΔMD and/or ΔMS T H/B F S Y

Often we will ignore the rest of the world THE TREASURY MODEL Often we will ignore the rest of the world Banks & Credit Fiscal Policy PrM X I G CrM BB/Def TRSY C ΔMD ΔMS Cash The FED T H/B S Y

Sometimes we will ignore Fiscal Policy THE FOREIGN MODEL Rest of the World Banks & Credit Sometimes we will ignore Fiscal Policy PrM X E I FxM K CrM C ΔMD ΔMS Cash The FED H/B F S Y

No Government or Foreign Sector THE BASIC MODEL Banks & Credit No Government or Foreign Sector PrM X I CrM C ΔMD ΔMS Cash The FED H/B S Y

THE CLOSED MODEL – an important conclusion, Part I PrM H/B X C Y TRSY T G FxM CrM F S K BB/Def If we start with a given amount of income (Y), we can picture that money flowing through the economy to where it ends up as spending (X). The rule for this model is: “All the money going into any box will equal the money going out of that box.” Question: “Is it possible that X is ever different from Y?” Answer: “X must always be the same as Y in the CLOSED MODEL” This should sound curious. We have a model that says that total spending (that is, GDP) never changes, when it obviously does in fact change. The model is, nevertheless surprisingly useful particularly as the LONG RUN MODEL.

THE CLOSED MODEL – an important conclusion, Part I PrM H/B X C Y TRSY T G FxM CrM F S K BB/Def “X must always be the same as Y in the CLOSED MODEL” This is so because the money that leaves Households and Businesses as Income must all go “somewhere.” That money must eventually wind up being spent, since there is nowhere else for it to go. This should sound curious. We have a model that says that total spending (that is, GDP) never changes, when it obviously does in fact change. The model is, nevertheless surprisingly useful particularly as the LONG RUN MODEL for demonstrating Classical/monetarist theory.

THE CLOSED MODEL – an important conclusion, Part II PrM H/B X C Y TRSY T G FxM CrM F S K BB/Def When we add either of two items to the diagram we get a new conclusion. With either ΔMD or ΔMS in the model it is now possible for X and Y to be different FED ΔMS Cash ΔMD BIG CONCLUSION: In order for GDP (spending) to rise or fall there must be a change in either the money supply or money demand. This is because money going to and from Cash or the Fed is going and coming from “nowhere.” The money more or less appears and disappears from the economy.

The OPEN Model – the Short Run picture PrM X Injections = Exports, Investment and Government Purchases Once we see that X and Y can be different we can build a simpler model. This is particularly useful for the Keynesian, short-run view of the economy. We will divide the economic flows into three parts. 1. Domestic Consumption: this is the part of income that immediately becomes spending. Cd 2. Leakages: these are the parts of income that are not immediately returned to the product market as spending. 3. Injections: these are the parts of total spending other than domestic consumption: the parts of spending that do not immediately arise out of current income. H/B Y Leakages = Imports, Saving and Taxes

The Three Models The OPEN Model the Short Run The MONEY Model Injections = E + I + G The MONEY Model the versatile one. This one can do what either of the others can PrM H/B X Cd Y E I PrM H/B X C Y TRSY T G FxM CrM F S K BB FED ΔMS Cash ΔMD Leakages = F + S + T The CLOSED Model the Long Run E I PrM H/B X C Y TRSY T G FxM CrM F S K BB