Transcript Demand for Money

Motives for Holding Money
• Transaction
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Motives for Holding Money
• Transaction
• Precautionary
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Motives for Holding Money
• Transaction
• Precautionary
• Portfolio
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Portfolio Motive
The precautionary and transaction motives
justify the classical economists’ argument
that income determines the demand for
money. The Portfolio motive distinguishes
the classical and Keynesian theory of
demand for money.
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Portfolio Motive
According to the Keynes, there is a
speculative motive for holding money.
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Portfolio Motive
According to the Keynes, there is a speculative motive for
People hold money to take
advantage of variation in bond prices in
response to the expected changes in interest
rates.
holding money.
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Bond Prices and Interest Rates
Perpetuity: Non-maturing bond that pays an
infinite stream of coupon returns.
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Bond Prices and Interest Rates
What is the current market price of a bond
that matures two years from now?
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Bond Prices and Interest Rates
What is the current market price of a bond
that matures two years from now?
PV = C/ (1+r) + C/ (1+r)2 + FV/ (1+r) 2
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Bond Prices and Interest Rates
What is the current market price of a bond
that matures n years from now?
PV = C/ (1+r) +… + C/ (1+r)n + FV/ (1+r)n
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Bond Prices and Interest Rates
What is the current market price of a
perpetuity ?
1)
PB = C/ (1+r) + C/ (1+r)2 + C/ (1+r)3
+ C/ (1+r)4 + C/ (1+r)5….
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Bond Prices and Interest Rates
What is the current market price of a
perpetuity ?
We can reduce equation # 1 to a simple
formula that shows the inverse relationship
between bond prices and interest rates.
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Bond Prices and Interest Rates
What is the current market price of a perpetuity ?
We can reduce this to a simple formula that shows the inverse relationship
. In order to do so we
should multiply both sides by (1+r).
between bond prices and interest rates
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Bond Prices and Interest Rates
What is the current market price of a perpetuity ?
We can reduce this to a simple formula that shows the inverse relationship
between bond prices and interest rates. In order to do so we should multiply
both sides by (1+r).
2)
(1+r) PB = C + C/ (1+r)1 + C/ (1+r)2 +
C/ (1+r)3 + C/ (1+r)4….]
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Bond Prices and Interest Rates
What is the current market price of a perpetuity ?
We can reduce this to a simple formula that shows the inverse relationship
between bond prices and interest rates. In order to do so we should multiply
both sides by (1+r).
If we subtract 1 from 2, we have:
(1+r) PB - PB = C + C/ (1+r)1 + C/ (1+r)2 + C/
(1+r)3 + C/ (1+r)4….] - [C/ (1+r)1 + C/
(1+r)2 + C/ (1+r)3 + C/ (1+r)4 ……..]
Copyright © 1998 Addison Wesley Longman, Inc.
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Bond Prices and Interest Rates
What is the current market price of a perpetuity ?
We can reduce this to a simple formula that shows the inverse relationship
between bond prices and interest rates. In order to do so we should multiply
both sides by (1+r).
If we subtract 1 from 2, we have:
(1+r) PB - PB = C + C/ (1+r)1 + C/ (1+r)2 + C/ (1+r)3 + C/ (1+r)4….] - [C/ (1+r)1 +
C/ (1+r)2 + C/ (1+r)3 + C/ (1+r)4 ……..]
eliminating those with +s and -s , we have :
Copyright © 1998 Addison Wesley Longman, Inc.
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Bond Prices and Interest Rates
What is the current market price of a perpetuity ?
We can reduce this to a simple formula that shows the inverse relationship
between bond prices and interest rates. In order to do so we should multiply
both sides by (1+r).
If we subtract 1 from 2, we have:
(1+r) PB - PB = C + C/ (1+r)1 + C/ (1+r)2 + C/ (1+r)3 + C/ (1+r)4….] - [C/ (1+r)1 +
C/ (1+r)2 + C/ (1+r)3 + C/ (1+r)4 ……..]
eliminating those with +s and -s , we have
(1+r) PB - PB = C
or
(1+r -1 ) PB = C
PB = C / r
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Bond Prices and Interest Rates
PB = C / r
This says that bond price , PB ,varies inversely
with interest rate, r. The higher the interest
rates the lower bond prices. Or, the higher
the bond prices the lower the interest rates.
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Bond Prices and Interest Rates
Question: If you expect interest rates to rise
(fall) tomorrow, what will you advise your
client?
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what determines the demand for
money?
• The Influences on Money Holding
• The quantity of money people hold depends on:
1) The price level
2) The interest rate
3) Real GDP
4) Financial innovation
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what determines the demand for
money?
• The Price Level
• Nominal money is the quantity of money
measured in dollars.
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what determines the demand for
money?
• The Price Level
• Nominal money is the quantity of money
measured in dollars.
• The quantity of nominal money
demanded is proportional to the price
level.
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what determines the demand for
money?
• The Price Level
• Nominal money is the quantity of money measured in dollars.
• The quantity of nominal money demanded is proportional to the price
level.
• Real money is the quantity of money measured
in constant dollars.
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what determines the demand for
money?
• The Price Level
• Nominal money is the quantity of money measured in dollars.
• The quantity of nominal money demanded is proportional to the price
level.
• Real money is the quantity of money measured
in constant dollars.
• The quantity of real money demanded is
independent of the price level.
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what determines the demand for
money?
The Interest Rate. The opportunity cost of
holding money is the interest rate a person
could earn on assets they could hold instead
of money.
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what determines the demand for
money?
• Real GDP
• Money holdings depend upon planned
spending.
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what determines the demand for
money?
• Real GDP
• Money holdings depend upon planned spending.
• The quantity of money demanded in the
economy as a whole depends on Real GDP.
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what determines the demand for
money?
• Financial Innovation
• Changing technologies affect the quantity of
money held.
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what determines the demand for
money?
• Financial Innovation
• Changing technologies affect the quantity of money held.
These
include:
• Daily interest checking deposits
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what determines the demand for
money?
• Financial Innovation
• Changing technologies affect the quantity of money held. These include:
• Daily interest checking deposits
• Automatic transfers between checking and
savings deposits
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what determines the demand for
money?
• Financial Innovation
• Changing technologies affect the quantity of money held. These include:
• Daily interest checking deposits
• Automatic transfers between checking and savings deposits
• Automatic teller machines
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what determines the demand for
money?
• Financial Innovation
• Changing technologies affect the quantity of money held. These include:
• Daily interest checking deposits
• Automatic transfers between checking and savings deposits
• Automatic teller machines
• Credit cards
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The Demand for Money
• The Demand for Money Curve
• The demand for money is the relationship
between the quantity of real money
demanded and the interest rate.
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Interest rate (percent per year)
The Demand for Money
6
5
4
MD
2.9
3.0
3.1
Real money (trillions of 1992 dollars)
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Interest rate (percent per year)
The Demand for Money
Effect of an
increase in
the interest
rate
6
5
4
Effect of an
increase in
the interest
rate
2.9
MD
3.0
3.1
Real money (trillions of 1992 dollars)
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The Demand for Money
• Shifts in the Demand Curve for Real Money
• Changes in real GDP or financial innovation
changes the demand for money and shifts the
demand curve for real money.
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Interest rate (percent per year)
Changes in the
Demand for Money
6
5
4
MD0
2.9
3.0
3.1
Real money (trillions of 1992 dollars)
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Interest rate (percent per year)
Changes in the
Demand for Money
6
5
4
Effect of decrease in
real GDP or financial
innovation
2.9
MD1
3.0
MD0
3.1
Real money (trillions of 1992 dollars)
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Interest rate (percent per year)
Changes in the
Demand for Money
Effect of increase
in real GDP
6
5
MD2
4
Effect of decrease in
real GDP or financial
innovation
2.9
MD1
3.0
MD0
3.1
Real money (trillions of 1992 dollars)
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The Demand for Money
in the United states
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