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PowerPoint to accompany

Money andInflation

Week 10Chapters 12& 13

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Sloman: Principles Of Economics 3e 2010 Pearson Australia

Learning Objectives

12.1 The meaning and functions of money What isthis thing called money?

12.2 - The financial system in Australia Where dobanks and other financial institutions fit in?

12.3 - The supply of money How is it measured andwhat determines its size?

12.4 The demand for money How much money dowe want to hold at any one time?

12.5 Equilibrium What effect does the demand andsupply of money have on interest rates?

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Money its meaning and functions

The functions of money

medium of exchange

means of evaluation or measure of value

means of storing wealth

Standard of deferred payments

What should count as money?

Back to Learning Objectives

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Australias Financial System

The role of the financial sector financial intermediaries

expert advice

expertise in channelling funds

maturity transformation

risk transformation

transmitting payments

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Banks

assets and liabilities

liabilities deposits

assets loans; currency; deposits with theReserve Bank of Australia (RBA)

Non-bank financial intermediariescredit unions, building societies, financecompanies


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Liabilities %

Deposits 74.3Bills accepted 6.5Other liabilities 19.2

100.0

Assets

Coins, notes, deposits with RBA 0.5Loans and advances

Residential 37.7

Personal 6.3Commercial 27.3Bills receivable 4.8

All other assets 23.4100.0

Assets & Liabilities of AustralianBanks, 2006

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Assets of Australiasfinancial institutions, 2009

(Table 12.1)

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The Reserve Bank of Australia: functions

issues notes

acts as a bank

holds the official foreign currency reserves

acts as a lender of last resort

operates monetary policy

stability of currency

maintenance of full employment

economic prosperity and welfare of people in Australia



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The Money SupplyMeasuring the money supply

monetary base

notes, coins, deposits held by banks atthe RBA

broad money

cash in circulation, bank deposits,deposits in NBFIs

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Alternative Measures of theMoney Supply, 2009 (Table 12.2)

$billionCurrency 46

Plus current deposits with banks 201

= M1 $247bnPlus other deposits with banks 933

= M3 $1180bn

Plus net borrowing from the private sector

by NBFIs 67

= Broad money $1247bn

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Example of credit creation (I):Banks original balance sheet

(Table 12.3)

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Example of credit creation (II):Initial effect of an additional deposit

of $10 billion (Table 12.4)

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Example of credit creation (III):The full effect of an additional

deposit if $10 billion (Table 12.5)

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The Supply of Moneythe bank multiplier

1/L where L = liquidity ratio

banks liquidity ratio may vary

banks may choose a different liquidity ratiocustomers may not want to take up the credit onoffer

banks may not operate a simple liquidity ratio

some of the extra cash may be withdrawnfrom the banks

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The Supply of Money

Relationship between the money supplyand the rate of interest

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0

R a

t e o

f i n

t e r e s

t

Quantity of money

MS

The Supply of Money Curve:(a) Exogenous Money Supply

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0

R a

t e o

f i n

t e r e s

t

Quantity of money

The Supply of Money Curve:(b) Endogenous Money Supply

MS


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The Demand for Money

The 3 motives for holding money

transactions motive

precautionary motive

assets motive or speculative demandfor money

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The Demand for MoneyDeterminants of the size of the demand for

moneynominal GDP

frequency with which people are paid

financial innovations

speculation about future return on assets

rate of interest

The demand for money curve

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0

R a

t e o

f i n t e r e s

t

MD

Quantity of money

The Demand for Money


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Equilibrium

Equilibrium in the money market

equilibrium interest rate

where demand for money (M d) andsupply of money (M s) are equal

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0

R a

t e o

f i n t e r e s

t

Md

Quantity of money

MS

r e

Me

Equilibrium in the Money Market

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EquilibriumFull effect of changes in the money supply(Ms)

Ms r (interest rates)

r I

, C I , C AD , GDP , inflation

r exchange rate X , M


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Learning Objectives13.1 Aggregate demand How does the

aggregate demand for goods and services varywith the price level?

13.2 Aggregate supply How does theaggregate supply for goods and services vary withthe price level?

13.3 Equilibrium The determination of GDPand the price level?

13.4 Demand-pull inflation How changes inaggregate demand change the price level.

13.5 Cost-push inflation How increases in costs

cause inflation.

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Aggregate demand

0

P r i c e

l e v e

l

GDP

AD1

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A shift in aggregate demand (I)

0

P r i c e l e v e

l

AD1

AD2

GDP

Demandexpands from AD1 to AD2

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A shift in aggregate demand (II)

0

P r i c e

l e v e

l

AD0

AD1

AD2

GDP

Demandcontracts from AD1 to AD0

A t l

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0

P r i c

e l e v e

l

GDP

Aggregate supply AS1

A hift i t l

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0

P r i c

e l e v e

l AS2 AS1

GDP

A shift in aggregate supply

Supply expands

from AS1 to AS2

A hif i l

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0

P r i c e

l e v e

l AS2 AS1 AS3

GDP

A shift in aggregate supply

Supply contractsfrom AS1 to AS3

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0

P r i c e

l e v e

l

GDP

AS

AD

Equilibrium price and GDP

GDPe

Pe

P2

P1

At price level P 1 ,aggregate supplyexceeds aggregate

demand. Both contracttowards equilbrium

point.

At price level P 2, aggregate demandexceeds aggregate

supply. Both contracttowards equilbrium

point.

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0

P r i c e

l e v e

l

AS

AD1

P1

GDP1

AD2

P2

GDP2 GDP

Demand-pull inflation

f

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0

P r i c e

l e v e

l

GDP

AS1

AD

P1

GDP1

Cost-push inflation AS2

P2

GDP2

Interaction: demand pull and cost push inflation (I)

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0

AS1

AD1

P1

Interaction: demand-pull and cost-push inflation (I)

GDP

P r i c e

l e v e

l

AD2

P2

GDP2GDP1

STAGE I : If theeconomy is alreadyat full employment,GDP 1, an increasein demand to AD 2,

will pull priceshigher, from P 1 to P 2

. Notional GDPtemporarily expandsfrom GDP 1 to GDP 2

and equilibrium fromE1 to E 2.

E1

E2

Interaction: demand pull and cost push inflation (II)

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0

AS1

AD1

P1

Interaction: demand-pull and cost-push inflation (II)

GDP

P r i c e

l e v e

l AS2

AD2

P2

GDP2GDP1

STAGE II : Firms areunable to expand

real supply becausethe economy isalready at full

employment, GDP 1.In response to

shortage of supply,prices increase

further, from P 2 to

P 3. GDP returns toits original, reallevel, GDP 1.

P3

E2

E3

Interaction: demand pull and cost push inflation (III)

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Sl P i i l Of E i 3 2010 P A li

0

AS1

AD1

P1

Interaction: demand-pull and cost-push inflation (III)

GDP

P

r i c e

l e v e

l

AS2

AD2

P2

GDP2GDP1

STAGE III : Theinteraction of

excessive demandand shortage of supply continues,

pushing prices evenhigher but withoutinducing any real growth in GDP.P3 E3

AD3

AS3

P4

E5

E4

Week 10SloCh12 13

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Transcript of Week 10SloCh12 13