CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc....
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Transcript of CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc....
![Page 1: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/1.jpg)
CHAPTER 13Money
CHAPTER 13Money
Chapter 30 in EconomicsChapter 30 in EconomicsChapter 30 in EconomicsChapter 30 in Economics
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TM 13-2Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define money and describe its functions
• Explain the economic functions of banks and other financial institutions
• Describe the financial innovations of the 1980s and 1990s
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TM 13-3Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how banks create money
• Explain why the quantity of money is an important economic magnitude
• Explain the quantity theory of money
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TM 13-4Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define money and describe its functions
• Explain the economic functions of banks and other financial institutions
• Describe the financial innovations of the 1980s and 1990s
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TM 13-5Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Money is any commodity or token that is generally acceptable as the means of payment.
• A means of payment is a method of settling a debt.
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TM 13-6Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Other functions of Money
1) Medium of exchange
2) Unit of account
3) Store of value
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TM 13-7Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Medium of Exchange
• A medium of exchange is an object that is generally accepted in exchange for goods and services.• Without money, people would have to exchange
goods for goods, or barter.
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TM 13-8Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Unit of Account
• A unit of account is an agreed measure for stating the prices of goods and services.• This simplifies value comparisons and purchase
decision making if all prices are expressed using a uniform measure.
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TM 13-9Copyright © 1998 Addison Wesley Longman, Inc.
The Unit of Account Functions of Money Simplifies Price Comparisons
Movie $6.00 each 2 six-packs of soda
Soda $3.00 per six-pack 2 ice-cream cones
Ice cream $1.50 per cone 3 packs of jelly beans
Jelly beans $0.50 per pack 2 cups of coffee
Coffee $0.25 per cup 1 local phone call
Price in Price in unitsGood money units of another good
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TM 13-10Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Store of Value
• A store of value is any commodity or token that can be held and exchanged later for goods and services.
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TM 13-11Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Money in the United States Today
• Money in the U.S. consists of:• Currency
• Deposits at banks and other financial institutions
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TM 13-12Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Money in the United States Today
• Currency is the bills and coins that we use.
• Deposits are also money because they can be converted into currency and are used to settle debts.
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TM 13-13Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Official Measures of Money
1) M1 consists of currency and traveler’s checks plus checking deposits.
• Includes accounts held by individuals and businesses, but does not include currency held by banks, or currency and checking deposits owned by the U.S. government
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TM 13-14Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Official Measures of Money
2) M2 consists of M1 plus saving deposits and time deposits
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TM 13-15Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Official Measures of Money
3) M3 consists of M2 plus large-scale time deposits and term deposits
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TM 13-16Copyright © 1998 Addison Wesley Longman, Inc.
Two Measures of Money
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TM 13-17Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Are M1 and M2 Really Money?
• The test of whether an asset is money is whether it serves as a means of payment.• Currency does so
• Checking deposits are money because they can be transferred by writing a check.
• M1 is money
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TM 13-18Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Are M1 and M2 Really Money
• Some savings deposits are readily accessible and can be used as a means of payment.
• Other deposits are less liquid.• Liquidity is the property of being instantly
convertible into a means of payment with little loss in value.
• M2 is money
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TM 13-19Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Other Points Regarding Money
1) Deposits are money but checks are not.
2) Credit cards are not money.
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TM 13-20Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define money and describe its functions
• Explain the economic functions of banks and other financial institutions
• Describe the financial innovations of the 1980s and 1990s
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TM 13-21Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Financial intermediaries are firms that take deposits from households and firms and makes loans to other households and firms.
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TM 13-22Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Four Types of Financial Intermediaries
1) Commercial banks
2) Savings and loan associations
3) Savings banks and credit unions
4) Money market mutual funds
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TM 13-23Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Commercial Banks
• A commercial bank is a firm, licensed by the Comptroller of the Currency or by a state agency to receive deposits and make loans.
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TM 13-24Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Commercial Banks
• Their balance sheet lists their assets, liabilities, and net worth.• The assets are what the bank owns
• The liabilities are what the bank owes
• These include deposits
• Net worth is the difference between assets and liabilities.
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TM 13-25Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Commercial Banks
• Their balance sheet is described by the following formula:
Liabilities + Net Worth = Assets
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TM 13-26Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Profit and Prudence: A Balancing Act
• Banks attempt to maximize the net worth of their stockholders• They earn profit by lending at a higher interest rate
than they borrows
• Lending is risky
• Banks must be prudent in how they uses their deposits
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TM 13-27Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Reserves and Loans
• Banks divide their funds into two parts:• Reserves are cash in a bank’s vault plus its deposits
at Federal Reserve banks
• Loans
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TM 13-28Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Three Types of Assets Held by Banks
1) Liquid assets are U.S. government Treasury bills and commercial bills
2) Investment securities are longer-term U.S. government bonds and other bonds
3) Loans are commitments of fixed amounts of money for agreed- upon periods of time
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TM 13-29Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Savings and Loan Associations
• A savings and loan association is a financial intermediary that receives checking deposits and savings deposits and that makes personal, commercial, and home-purchase loans.
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TM 13-30Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Savings Banks and Credit Unions
• A savings bank (mutual savings bank) is a financial intermediary owned by its depositors that accepts deposits and makes mostly home-purchase loans.
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TM 13-31Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Savings Banks and Credit Unions
• A credit union is a financial intermediary owned by its depositors that accepts savings deposits and makes mostly consumer loans.• The key difference between savings banks and
credit unions is that credit unions are owned by a social or economic group such as a firm’s employees.
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TM 13-32Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Money Market Mutual Funds
• A money market mutual fund is a financial institution that obtains funds by selling shares and uses these funds to buy highly liquid assets such as U.S. Treasury bills
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TM 13-33Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• The Economic Functions of Financial Intermediaries
1) Creating Liquidity
2) Minimizing the cost of borrowing
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TM 13-34Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• The Economic Functions of Financial Intermediaries
3) Minimizing the cost of monitoring borrowers
4) Pooling Risk
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TM 13-35Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Financial Regulation
• Two types of regulation faced by financial intermediaries:• Deposit insurance
• Balance sheet rules
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TM 13-36Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Deposit Insurance
• The deposits of most financial intermediaries are insured by the Federal Deposit Insurance Corporation.• Receives its income from compulsory premiums
paid by financial intermediaries
• Protects depositors
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TM 13-37Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• The balance sheet regulations faced by financial intermediaries include:
1) Capital requirements• The minimum amount of an owner’s own financial
resources that must be put into an intermediary
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TM 13-38Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• The balance sheet regulations faced by financial intermediaries include:
2) Reserve requirements• Rules setting out the minimum percentages of
deposits that must be held in currency or other safe, liquid assets
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TM 13-39Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• The balance sheet regulations faced by financial intermediaries include:
3) Deposit rules• Restrictions on the different types of deposits that
an intermediary can accept
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TM 13-40Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• The balance sheet regulations faced by financial intermediaries include:
4) Lending rules• Restrictions on the proportions of different types of
loans that an intermediary may make
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TM 13-41Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Deregulation in the 1980s
• The Depository Institutions’ Deregulation and Monetary Control Act (DIDMCA), passed in 1980, removed many of the distinctions between commercial banks and other financial intermediaries.
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TM 13-42Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Deregulation in the 1980s
• Other actions affecting financial intermediaries include:• The passage of the Garn-St. Germain Depository
Institutions Act in 1982
• The abolition of Regulation Q in 1985
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TM 13-43Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define money and describe its functions
• Explain the economic functions of banks and other financial institutions
• Describe the financial innovations of the 1980s and 1990s
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TM 13-44Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Financial Innovation
• Financial innovation is the development of new ways of borrowing and lending.• Primary aim is to increase the profit from financial
intermediation
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TM 13-45Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• The three main influences on financial innovation are:
1) Economic environment
2) Technology
3) Regulation
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TM 13-46Copyright © 1998 Addison Wesley Longman, Inc.
Financial Regulation, Deregulation, and Innovation
• Financial Innovations
• Variable interest rate mortgages
• Widespread credit card usage
• Rise in the importance of the Eurodollar
• Paying interest on checkable deposits
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TM 13-47Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how banks create money
• Explain why the quantity of money is an important economic magnitude
• Explain the quantity theory of money
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TM 13-48Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Reserves: Actual and Required
• The reserve ratio is the fraction of a bank’s total deposits that are held in reserves.
• The required reserve ratio is the ratio of reserves to deposits that banks are required, by regulation, to hold.
• Excess reserves are actual reserves minus required reserves.
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TM 13-49Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Creating Deposits by Making loans in a One-Bank Economy
Let’s see an example of howbanks create money.
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TM 13-50Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $100 Deposits $400
Loans $300
Total $400 Total $400
Creating Money at theOne-and-Only Bank
Balance sheet on January 1
Assets(millions of dollars)
Liabilities(millions of dollars)
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TM 13-51Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $101 Deposits $401
Loans $300
Total $401 Total $401
Creating Money at theOne-and-Only Bank
Balance sheet on January 2
Assets(millions of dollars)
Liabilities(millions of dollars)
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TM 13-52Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $101 Deposits $404
Loans $303
Total $404 Total $404
Creating Money at theOne-and-Only Bank
Balance sheet on January 3
Assets(millions of dollars)
Liabilities(millions of dollars)
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TM 13-53Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• The Deposit Multiplier
reservesinChange
depositsinChangemultiplierDeposit
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TM 13-54Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Creating Deposits by Making Loans with Many Banks
Let’s see how the
banking system creates money
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TM 13-55Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
![Page 56: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/56.jpg)
TM 13-56Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
![Page 57: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/57.jpg)
TM 13-57Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000Loan
$75,000Reserve$25,000
![Page 58: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/58.jpg)
TM 13-58Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence
Deposit$100,000
Loan$75,000
Deposit$75,000
Reserve$25,000
The running tallyReserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000
![Page 59: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/59.jpg)
TM 13-59Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000Loan
$75,000
Deposit$75,000
Reserve$25,000
Loan$56,250
Reserve$18,750 $43,750 $131,250 $175,000
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TM 13-60Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence
Deposit$56,250
The running tallyReserves Loans Deposits
![Page 61: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/61.jpg)
TM 13-61Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$43,750 $131,250 $175,000
Deposit$56,250
Loan$42,187
Reserve$14,063 $57,813 $173,437 $231,250
![Page 62: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/62.jpg)
TM 13-62Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
Deposit$56,250
Loan$42,187
Reserve$14,063
Deposit$42,187
$43,750 $131,250 $175,000
$57,813 $173,437 $231,250
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TM 13-63Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$68,360 $205,077 $273,437
Loan$31,640
Reserve$10,547
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TM 13-64Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$68,360 $205,077 $273,437
Loan$31,640
Reserve$10,547
andso on...
$100,000 $300,000 $400,000
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TM 13-65Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• The Deposit Multiplier in the United States
• The actual deposit multiplier in the U.S. works the same as the one presented.
• However, it does differ in some aspects.
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TM 13-66Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• The deposit multiplier in the United States differs from our model economy’s for three main reasons:
1) The actual required reserve ratio is smaller than the 25 percent used here.
2) Banks sometimes choose to hold excess reserves.
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TM 13-67Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• The deposit multiplier in the United States differs from our model economy’s for three main reasons:
3) Not all loans made by banks return to them in the form of reserves.
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TM 13-68Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how banks create money
• Explain why the quantity of money is an important economic magnitude
• Explain the quantity theory of money
![Page 69: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/69.jpg)
TM 13-69Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• We are going to study the effect the money supply has on real GDP, the price level, and the inflation rate.
![Page 70: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/70.jpg)
TM 13-70Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Short-Run Effects of a Change in the Quantity of Money
• Let’s study how a change in the quantity of money effects these factors by examining the aggregate supply-aggregate demand model.
![Page 71: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/71.jpg)
TM 13-71Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
120
107
6.8 7.4
![Page 72: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/72.jpg)
TM 13-72Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
AD0
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 73: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/73.jpg)
TM 13-73Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
AD0
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 74: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/74.jpg)
TM 13-74Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 75: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/75.jpg)
TM 13-75Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
![Page 76: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/76.jpg)
TM 13-76Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
AD1
SAS1
![Page 77: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/77.jpg)
TM 13-77Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
![Page 78: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/78.jpg)
TM 13-78Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
![Page 79: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/79.jpg)
TM 13-79Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
SAS2
![Page 80: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/80.jpg)
TM 13-80Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD2
SAS2
![Page 81: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/81.jpg)
TM 13-81Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how banks create money
• Explain why the quantity of money is an important economic magnitude
• Explain the quantity theory of money
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TM 13-82Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Quantity Theory of Money
• The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level.
• This theory is based upon the velocity of circulation and the equation of exchange.
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TM 13-83Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Quantity Theory of Money
• The velocity of circulation is the average number of times a dollar of money is used annually to buy goods and services that make up GDP.
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TM 13-84Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• GDP equals the price level (P) times real GDP (Y), or:
GDP = PY
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TM 13-85Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Make the quantity of money M, and the velocity of circulation V is determined by:
V = PY/M
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TM 13-86Copyright © 1998 Addison Wesley Longman, Inc.
The Velocity of Circulation in the United States: 1930–1996
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TM 13-87Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The equation of exchange states that the quantity of money (M) multiplied by the velocity of circulation (V) equals GDP, or
MV=PY
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TM 13-88Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• We can convert the equation of exchange into the quantity theory of money by making two assumptions:
1) The velocity of circulation is not influenced by the quantity of money.
2) Potential GDP is not influenced by the quantity of money.
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TM 13-89Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Assuming this is true, the equation of exchange tells us that a change in the quantity of money causes an equal proportional change in the price level.
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TM 13-90Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• This can be shown by using the equation of exchange to solve for the price level.
P = (V/Y)M
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TM 13-91Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• In the long run, real GDP equals potential GDP, so the relationship between the change in the price level and the quantity of money is:
MYVP )/(
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TM 13-92Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Dividing this equation by an earlier one, P = (V/Y)M, gives us
MMPP //
![Page 93: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/93.jpg)
TM 13-93Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• This equation shows that the proportionate change in the price level equals the proportionate change in the quantity of money.
• This gives us the quantity theory of money:
• In the long run, the percentage increase in the price level equals the percentage increase in the quantity of money.
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TM 13-94Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The AS-AD model predicts the same outcome as the quantity theory of money.
• It also predicts a less precise relationship between the quantity of money and the price level in the short run than in the long run.
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TM 13-95Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Historical Evidence on the Quantity Theory of Money
• The data are broadly consistent with the quantity theory of money, but the relationship is not precise.
• The relationship is stronger in the long run than in the short run.
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TM 13-96Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the United States
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TM 13-97Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the United States
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TM 13-98Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the World Economy
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TM 13-99Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the World Economy
![Page 100: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/100.jpg)
TM 13-100Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Correlation, Causation, and Other Influences
• The evidence shows that money growth and inflation are correlated.
![Page 101: CHAPTER 13 Money Chapter 30 in Economics. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define money and describe its functions.](https://reader035.fdocuments.us/reader035/viewer/2022062409/5697bfd11a28abf838cab0c8/html5/thumbnails/101.jpg)
TM 13-101Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Correlation, Causation, and Other Influences
• This does not represent causation.• Does money growth cause inflation, or does
inflation cause money growth?
• Does some other factor cause inflation (deficit spending)?