1. The Demand ECO 473 - Money & Banking - Dr. D. Foster for Money

2. The Demand for Money motivesThe motives for holding money medium of exchangeMoney demand as a medium of exchange  The Cambridge equation.  The Inventory model.  Friedman approach.  Rothbard approach. store of valueMoney demand as a store of value  Keynes’ portfolio demand.

3. The Motives for Holding Money Transactions motiveTransactions motive:  To use as a medium of exchange.  Depends upon income, consumption, wealth.  Not influenced very much by interest rates. Portfolio motivePortfolio motive:  To hold money as part of a wealth building strategy.  Depends on the interest rate.

4. The Cambridge Equation Money is only used for making purchases. Y k For some given income, Y, you plan to hold some given fraction, k, to facilitate purchases. risesfalls risesfalls As income rises (falls), the money demanded rises (falls).

5. The Demand for Real Money Balances M d is a “nominal” value - as prices rise, we want to hold more money, but not in real terms. So, to convert to “real” values... Y = nominal income = (Prices) x (real income) = Py m d eliminates price effects on money demand.

6. Annual Spending Patterns with a Constant Rate of Spending for y = $36,000 Average money holdings equals … ? $18,000 $9,000 $1,500

7. The Inventory Approach to Money Demand What is the optimal money balance to hold? Assumptions:  On-hand money earns no interest.  People earn a fixed amount of real income.  People buy goods and services at a constant rate.  People hold either money or bonds.  Bonds earn an interest return of r.  Converting from bonds to money costs a fee, f.  Conversion made n times/year in constant amounts.

8. Summarizing factors affecting m d - real money balances Real incomeReal income: ym d  A rise in y causes an increase in m d. ym d  A fall in y causes a decrease in m d. The interest rateThe interest rate: rm d  An increase in r causes a decrease in m d. rm d  A decrease in r causes an increase in m d. The cash-conversion feeThe cash-conversion fee: fm d  An increase in f causes an increase in m d. fm d  A decrease in f causes a decrease in m d.

9. Friedman approach Money demand varies with … Permanent Income.Permanent Income.  + relationship. Interest spread between bonds & money.Interest spread between bonds & money.  - relationship. Interest spread between stocks & money.Interest spread between stocks & money.  - relationship. Inflationary expectations.Inflationary expectations.  - relationship.

10. Rothbard approach Money demand varies with … Frequency of payments.Frequency of payments.  - relationship. Sophistication of the clearing system.Sophistication of the clearing system.  - relationship. Confidence in money (esp. paper).Confidence in money (esp. paper).  + relationship. Inflationary expectations.Inflationary expectations.  - relationship. Mises: Phase I Phase II Phase III

11. Rothbard presentation Money S&D in the context of the ppm: m s' ppm msms $ mdmd m d'' m d' In Phase I, MS rises but its effects are offset by  Md. In Phase II, Md falls, incorporating inflationary expectations. Phase III, further increases in MS are constantly offset by declines in Md as people seek to have zero cash.

12. Keynes & the Portfolio Demand speculative demandThe speculative demand for money: store of value  Relates to money held as a store of value. maximize our wealth  We seek to maximize our wealth over time. bonds  Our wealth is held in the form of bonds. time bond purchases  Holding money allows us to time bond purchases. high buy bonds  At “high” interest rates, we expect them to fall … raising bond prices; strategy - buy bonds now. low sell bonds  At “low” interest rates, we expect them to rise … lowering bond prices; strategy - sell bonds now.

13. Keynesian Money Demand r m m d(S) m d(T) r m Money demanded for transactions purposes in the Cambridge equation isn’t related to the interest rate. [Also, Friedman & Rothbard.] Keynes’ speculative demand shows money is related to the interest rate.

14. The Liquidity Trap Increasing the MS doesn’t actually lower interest rates! Or, increasing the MB doesn’t actually increase the MS!

15. Is the U.S. in a Liquidity Trap? Fight Recession by  interest rates The Fed has run out of an interest rate policy! 1982 1991 2001 2009

16. 2004-2008: ~ $800 b. 9/2015: $4,028 b. What has the Fed done? The Monetary Base has more than quintupled!

17. The Demand ECO 473 - Money & Banking - Dr. D. Foster for Money