Chapter 4: Money Market Analysis Gang Gong March 10. 2002 Copyright Notes: This electronic file is only used as a lecture notes for the student in this class It is not allowed to be used for presentation anywhere else without the permission from the author
Chapter 4: Money Market Analysis Gang Gong March 10, 2002 Copyright Notes:This electronic file is only used as a lecture notes for the student in this class. It is not allowed to be used for presentation anywhere else without the permission from the author
Introduction The objective of this chapter is to study how money and interest rate is determined in the money and financial market The money and financial market is the market in which money and various financial assets(such as, bonds and stocks) are exchanged
Introduction • The objective of this chapter is to study how money and interest rate is determined in the money and financial market. • The money and financial market is the market in which money and various financial assets (such as, bonds and stocks) are exchanged
Introduction The Functions of Money Medium of Exchange Store of value Unit of account
Introduction • The Functions of Money – Medium of Exchange – Store of Value – Unit of Account
Introduction Types of Money in Modern Economy with Banking System M1: Currency and Notes(issued by central bank), also called high powered money or monetary base checkable deposit M2: Non-checkable saving deposit etc M3: Large time deposit Note: MI is the most liquid money followed by m2 and M3
Introduction • Types of Money in Modern Economy with Banking System: – M1: • Currency and Notes (issued by central bank), also called high powered money or monetary base. • checkable deposit. – M2: Non-checkable saving deposit etc. – M3: Large time deposit Note: M1 is the most liquid money followed by M2 and M3
The Demand for Money Transaction Demand for Money Money is an medium of transaction. The transaction demand for money is those money that is hold for transactionary purpose. It is assumed to be related to nominal gdp
The Demand for Money • Transaction Demand for Money: — Money is an medium of transaction. The transaction demand for money is those money that is hold for transactionary purpose. It is assumed to be related to nominal GDP
The Demand for Money Asset Demand for money Money is also an asset However, unlike the other assets, such as bonds, stocks, etc. money M1 does not generate interest rate(its only advantage is the liquid). Therefo it can be expected that when interest rate of other assets increase, the demand for money will decline
The Demand for Money Asset Demand for Money – Money is also an asset. However, unlike the other assets, such as bonds, stocks, etc., money (M1) does not generate interest rate (its only advantage is the liquid). Therefore it can be expected that when interest rate of other assets increase, the demand for money will decline
The Demand for Money The Total Demand for Money The total demand for money is the sum of transaction demand for money and asset demand for money. We thus can write the demand function for money as M=kHi (see Figure presented in class
The Demand for Money • The Total Demand for Money – The total demand for money is the sum of transaction demand for money and asset demand for money. We thus can write the demand function for money as (see Figure presented in class) M k Y hi d = −
The Supply of money and money Market Equilibrium The supply of money is often assumed to be controlled by the central bank, and therefore It Is exogenuous M=M
The Supply of Money and Money Market Equilibrium • The supply of money is often assumed to be controlled by the central bank, and therefore it is exogenuous: M M s =
The Supply of money and money Market Equilibrium The money market equilibrium is the condition at which ms=Md M=kY-hi Therefore, given the money supply and nominal gdp. it is the interest variation that ensures the money market equilibrium
The Supply of Money and Money Market Equilibrium • The Money Market Equilibrium is the condition at which Therefore, given the money supply and nominal GDP, it is the interest variation that ensures the money market equilibrium. M s M d = M = k Y − hi
The Supply of money and money Market Equilibrium · How Does the interest rateⅤ ariation Ensure the money market Equilibrium (mechanism analysis) Suppose the interest rate to be lower than the equilibrium interest rate. In this case the ere v be an excess demand for money indicating people will sell their bonds to exchange for money
The Supply of Money and Money Market Equilibrium • How Does the Interest Rate Variation Ensure the Money Market Equilibrium (mechanism analysis) – Suppose the interest rate to be lower than the equilibrium interest rate. In this case, there will be an excess demand for money indicating people will sell their bonds to exchange for money