III.EQUALIBRIUM IN THE M. MARKET

I.MONEY SUPPLY

M. SUPPLY- sun of money that narrowly or broadly defined

‘NEAR’ M.- large or small scale deposits; highly liquid assets (other than cash)

M. SUPPLY CURVE shows the relationship between int. rate and M. supply

2 POINTS OF VIEW ON M. SUP. CURVE:

1) Keynesian (graph: diag ne ot 0) (Ms-endogenous var.-depends on int. rate)

Reasons that as r!=>!Ms:

-!Ms as a result of banks expanding credit in response to dem. for credit=> banks have surplus liquidity in the 1^st place. !dem. for money=>!r, more profitable for banks to supply more credit.

-!r encourage depositors to switch their deposits from sight accounts (earning little or no r) to time accounts. M. is less less likely to be withdrawn quickly from time accounts, banks may feel the need to hold less liquidity, and therefore may decide to increase credit, thus expanding Ms

-!r attract deposits from overseas.=> !Ms to the extend that they were nat.cur. deposits held abroad and National Bank doesn’t allow exchange rate to appreciate in response

2) Monetarists (graph: vert) (Ms-exogenous var.-doesn’t depend on int. rate as it is determined by gov. independently on changes in int. rate)

MODERN BANKING SYSTEM- fractional reserve banking system (only a fraction of deposits are kept in reserves, others can be lent)

!M. that bank has, !level of creditability=>!level of circulation of M. in the economy

CREDIT CREATION PROCESS- when banks increase the amount of M. in the economy due to lending ability (is called MULTIPLE DEPOSITS EXPANSION)

2 MAIN ASSUMPTIONS:

-bank system is represented only by 1 bank (all deposits are concentrated in 1 bank)

-liquidity ratio (proportion of M. in the bank again; proportion of bank’s total assets held in liquid form)

dMs=dD*Kl

dMs- ! in Ms

dD-deposits

Kl-bank multiplier or money/monetory/ demand deposit multiplier- the number of times that the expansion of money is greater than expansion liquidity that caused it.

Kl=1/l-liquidity ratio (it may be used to evaluate a lending ability of the banking system)

Maximum dem. deposit expansion=excess reserves

MONEY MULTIPLIER- number of times greater the expansion of Ms is than expansion of the monetary base that caused it (dMs/dMb)

INITIAL BANK’S BALANCE SHEET

Liabilities (incl. deposits)=Assets (incl. balances with Central Bank, advances)

FACTORS DEMINISHING CREDIT CREATION

1) Currency circulation outside the bank sector (currency outflow)

!currency outflow=>|possibilities for cr. creation proc.

2) High required reserves (HRR)

!HRR=>|lendind ability of banks

3) Unwillingness of people to borrow money

e.g.: due to high r, no confidence in banking sector

MAIN DETERMINANTS OF Ms IN THE ECONOMY

1) MONETORY BASE- total number of currency held by the public as cash and by the bank as reserves

2) RESERVE DEPOSIT RATIO- fraction of deposits held in reserves (inverse relation)

3) CURRENCY DEPOSIT RATIO(CDR)- ratio of money held in the form of currency to M. held in the form of dem. deposits. (!CDR=>|Ms(people keep money in pockets))

4) INFLOW OF FUNDS (OR M.) FROM ABROAD

II.MONEY DEMAND

LIQUIDITY PREFERENCE- desire to held assets in a liquid form (most liquid-cash)

2 reasons why people need cash- 2 components of Md

L=L1+L2

L1-active balances or transaction dem. for M. (M. for transaction and for precautionary purposes (e.g.:‘black day’))

L2-idle balances or asset dem. for M., M. held in anticipation of a fall in asset prices (for speculation purposes)

MAIN DETERMINANTS OF Md

L1 (active bal.)

-National income (!Y=>!number of transactions in the economy=>!L1)

-Frequency of payments (|freq.=>!M. people need for payments=>!L1)

-Int. rate (|r=>!desire to held money in liquid form but not in banks=>!L1)

-Season of year (!L1 in summer, on holidays)

L2 (idle bal)

-expectations about changes in security prices and r. on this securities (|expected securities=>!expected r=>!people spend M. on purchasing securities=>|L2)

-chnges in exchange rate (of domestic currency) (!exchange rate=>!desire to hold M. in domestic currency=>!L2)

POINTS OF VIEW ON Md CURVE

MONETORISTS (graph: pochti vert. duga)

-L is inelastic (as it is mainly a medium of exchange) L=L1 (people need money only for transactions) if !r=> people prefer to buy G&S (not securities)=>very small |Md

-L-stable (doesn’t shift unpredictably)

KEYNESIAN (graph: bolee pologaya duga)

-L is elastic as L2 are significant and M. in cash, fin. assets substitute each other. (!r=>people prefer to buy securities or keep money in banks as deposits; !securities you buy=>|L2=>|L)

-L is instable (nobody can predict the behavior of speculators)

III.EQUALIBRIUM IN THE M. MARKET

Ms=L at each type of assets and at average r

Mechanism at the M. market

Assume R1>Re

-surplus in M. balances occurs=> Ms>L (people begin to buy securities=>!price for securities=>|r of securities and average r=>inverse movement of r=>restore equil.)

-excess bank reserves appear=> |r=> restore equal.

MONETARY TRANSMISSION MECHANISM (MTM)

…influence of changes in Ms on Y and AD

1) Direct MTM- Monetarists’ concept.

Assume !Ms=>Ms>Md=>people spend surplus=>AD!=>unchanged Y, !P (pure dem.-pull infl.)

Graph: vert. AS, 3 AD, initial AD-bottom curve

2) Indirect MTM- Keynesian concept

!Ms=>!AD=>!Y

a) via r

b) via exchange rate

3) Some economists believe that !Ms doesn’t lead to !Y (AD) at all- LIQUIDITY TRAP

graph: Ms,L, Ms1(left)=>Msn(right); Ro=> L-vert. part.

to stimulate business activity Ms!=> |r, but Ro-min. level of r

Where it is impossible to buy securities and speculators prefer to keep M. in L2 expecting future !r in L2, not in L1=> no changes in AD

MONETORY POLICY

Date: 2015-12-11; view: 796