Transcript money supply

Money, Interest Rates, &
Exchange Rates
• Determination of exchange rates:
1. How interest rates are determined;
2. How expectations of future exchange
rates are formed.
money supply
1. Interest rate
2. Expectation
money demand
Exchange rates
Money?
•
Distinguish money from other assets
1. As a Medium of Exchange
2. As a Unit of Account
3. As a Store of Value
马克思的货币概念
Money Supply
= the monetary aggregate the Federal Reserve
calls M1.
=the total amount of currency and checking
deposits held by households and firms.
Demand for money by individuals
Amount of money an individual desire to hold
1. Expected return (money and other
assets)
2. Riskiness of the asset’s expected return
3. The asset’s liquidity
Aggregate Money Demand →
→Md
1. The interest rate → → R
2. The price level → → P
3. Real national income → → Y
M d P  L( R, Y )
M d  P  L ( R, Y )
L(R, Y) =
aggregate real
money demand
R
Increase in real income Y,
cause the whole demand
schedule to shift upward.
L(R,Y)
For a given real income level, Y, real money
demand rises as the interest rate falls.
Money Supply
M M
S
d
deviding both sides by P
M / P  L( R, Y )
s
Equilibrium in the money market:
The money supply schedule is vertical
at Ms/P because Ms is set by the central bank
while P is taken as given.
R
Real money supply
Ms
( Q)
P
Aggregate real
money demand
L(R,Y)
If there is an excess supply of money, then R↓
If there is an excess demand of money, then R↑
R
Real money supply
Ms
( Q)
P
Aggregate real
money demand
②
①
L(R,Y)
An increase in real output raises the interest rate, and
vice versa, given the price level and money supply.
Money supply & exchange rate
in the short run
• The previous assumption: price level (real
output) given:
• In the short run:
• money supply↑→interest rate & exchange
rate
• In the long run:
• money supply ↑→price level & exchange
rate and other macroeconomic variables
Linking money, interest rate, &
exchange rate
• P375
• Simultaneous equilibrium in money market
and the foreign exchange market.
③本币贬值↑ exchange
rate
Foreign exchange
market
return on
domestic
deposit
②影响本国利率
domestic
interest
Money market
expected
return on
foreign
deposit
Rates of return
L (R, Y)
money
supply
①本币货币供应增加
money holdings
假定：两国价格
水平与国民收入
不变。
Conclusions
• An increase in a country’s money supply
causes its currency to depreciate in the
foreign exchange market
• A reduction in a country’s money supply
causes its currency to appreciate in the
foreign exchange market.
Money, price level, & exchange
rate in the long run
• Monetary factors →price level in the long run.
• An economy’s long-run equilibrium is reached if
prices were perfectly flexible and always
adjusted immediately to preserve full
employment.
• Tool: the theory of aggregate money demand.
exchange
rate
Foreign exchange
market
return on
domestic
deposit
①外国货币
供给增加
②本币贬值
domestic
interest
Money market
Rates of return
L (R, Y)
money
supply
③本国货币市场
维持原状。
money holdings
Money & Money Prices
• If the price level & output are fixed in the
short run, money market equilibrium:
s
M
 L ( R, Y )
P
Money supply = Money demand
s
M
P
L ( R, Y )
①P, Y, R can vary in the
long run.
②Price level depends
on …
s
M
P
L ( R, Y )
Proportional Change
Remain Unchanged
• All else equal, an increase in a country’s
money supply causes a proportional increase in
its price level.
The long-run effects of money
supply changes
• A change in the supply of money has no effect
on the long-run values of the interest rate or
real output.
e.g. currency reform
• A permanent increase in the money supply
causes a proportional increase in price
level’s long-run value. If the economy is
initially at full employment, a permanent
increase in the money supply eventually will
be followed by a proportional increase in the
price level.
Empirical evidence:
Relation between Ms and P:
• No proportional relationship over long
period;
• A clear-cut positive association between
them.
Case in Industrialized Countries
P
Long term;
Positive
correlation;
Proportional
changes
Ms
Case in Latin America-time series
Strong positive
relationship
Price
level
Money
supply
Money & Exchange Rate in the
long run
• A permanent increase in a country’s money
supply causes a proportional long-run
depreciation of its currency against foreign
currencies and vice versa.
Short-run price rigidity vs. long-run
price flexibility
• Prices are written into long-term contracts;
• The most important prices are workers’ wages;
• Workers’ wages do not enter indices of the price
level directly, but they constitute the cost of
production;
• Wages influence the overall price level;
• The short-run “stickiness” of price
level; (Chinese presumptions)
The exchange rate is much more variable than relative price
level; The price levels are relatively rigid in the short run
and they will not jump in response to policy changes.
There are some exceptions of shortrun stickiness of price levels
1. Excess demand for output and
labor;
2. Inflationary expectations;
3. Raw materials prices;
Permanent money supply
changes & the exchange rate
• P. 389
• Notice that the dollar depreciation is greater
than it would be if the future dollar/euro
exchange rate stayed fixed (as it
might if the money supply increase temporary
rather than permanent). If the expectation E$e/ E
did not change, the new short-run equilibrium
would be at point 3’ rather than at point 2’.
Start from MS ↑
Short-run effects
Adjustment to longrun equilibrium
Exchange rate overshooting
• The exchange rate is said to overshoot when its
immediate response to disturbance is greater
than its long-run response. Exchange
rate overshooting is an important
phenomenon because it helps explain why
exchange rates move so sharply from day to day.
• The explanation comes from the interest parity
condition.
Time paths of U.S. economic variables after a permanent increase in the
U.S money supply
中文翻译
Overshooting
• Overshooting is a direct consequence
of the short-run rigidity of the
price level.
• In a hypothetical world where the price
level could adjust immediately to its new
long-run level after a money supply
increase, the dollar interest rate would not
fall because prices would adjust
immediately and prevent the real money
supply from rising.
Development of “Overshooting”
• Chinese version 由于商品价格粘性的
存在，当货币供给一次性增加以后，本币
汇率的瞬间贬值程度大于长期贬值程度，
该现象为汇率超调。
• 在短期内，总供给曲线是水平的，价格水
平不发生调整，货币供给的一次性增加只
是造成本国利率的下降，本币汇率的贬值
超过长期平衡水平，本国产出超过充分就
业水平。
• 预期的未来汇率水平不变，导致汇率调
整的主要因素是本国利率的调整。
• 随着利率的逐步提高，实际汇率也逐步
升值并向其长期平衡水平趋近。
• 一直持续到均衡状态：价格水平发生与
货币供应量的增加同比率上涨。此时，
购买力平价成立。
超调模型的评价
• 创立了动态汇率学；
• 会使购买力平价短期不成立；