week 1 update foundations of monetary economics

EPPE 6124 Monetary Economics- Foundations of Monetary Economics -

Main References:Handa (chapt 1), Walsh (chapt 1), Mishkin (chapt 1)

Norlin Khalid

School of Economics, Faculty of Economics and Management,Universiti Kebangsaan Malaysia

February 20, 2014

Monetary EconomicsThe Concept of Money

Why do we Study Monetary EconomicsStylized Facts: Money and Economic Aggregates

Why Study Monetary Economics?

Empirical evidence suggest that money plays an important role ingenerating business cycles Recessions (unemployment) andexpansions - to study the relationship between money andbusiness cycle, money and output as well as money and inflation.

monetary policy acts as a stabilization policy and not a growthpolicy.

study the conduct of an optimal monetary policy

Norlin Khalid EPPE 6124 Monetary Economics - Foundations of Monetary Economics -



Money Growth (M2 annual rate) & Business Cycle inU.S (1950-2011)




Aggregate Price Level & Money Supply in U.S(1950-2011)




Average Inflation Rate Vs. Average Rate of MoneyGrowth for Selected Countries (2000-2010)




Stylized Facts - Long Run Correlations

The correlation between long run infation and moneygrowth is almost one across countries

McCandles & Weber (1995) - data 30-year from 110 countriesusing several definitions of money - coe of corr varies between0.92 and 0.96A change in the growth rate of money induces an equal change inthe rate of price inflation





There is no clear long run correlation between inflationand the growth of real output or between money growthand the growth of real output.

Some find positive correlations between money growth andoutput, ex: McCandless & Weber (1995) for OECDSome find no LR correlation between money growth and outputgrowth, ex: Geweke (1986)Some find negative correlation between inflation and output, ex:Barro (1995, 1996)Results hinge on which countries are used and therefore, long runeects on output are less robust





The relationship between interest rates, inflation and money.

Inflation and nominal interest rates in the long run?

Fisher equation: it = rt + Ett+1In steady-state, i ss = r ss + ss

If real returns are independent of inflation, then higher long-runinflation should raise long-run interest rates (roughly confirmed byempirical analyses, see Mishkin (1992), Moneet & Weber (2001))




Monetary Economics?

Anything that central bankers should be interested in - studiesthe formulation of monetary policy, usually by the central bankor the monetary authority, supply of money and interest rates -what is actually done and what would be optimal.

It investigates the relationship between real economic variables atthe aggregate level and nominal variables - has considerableoverlap with macroeconomics.

It focuses on the monetary and other financial markets, thedetermination of the interest rate, the extent to which theseinfluence the behavior of the economic units and the implicationsof that influence in the macroeconomic context.



What is money and what does it do?Money Market

The concept of Money

Definition of money is a bit tricky - Money is anything thatgenerally accepted...although with no intrinsic value.

In economics money is defined as an asset (a store of value) whichfunctions as a generally accepted medium of exchange, i.e., it canin principle be used directly to buy any good.

Generally accepted mediums of exchange are also called means ofpayment. So money is characterized by being a fully liquid asset -Thus, an assets liquidity is the ease with which the asset can beconverted into money or be used directly for making payments.

M1 -defined as currency in circulation + demand deposits held bythe non-bank public in commercial banks. Thus M1 embraces allin practice fully liquid assets in the hands of the non-bank public.




Historical Remark

1 Commodity Money

such as seashells, rice, cocoa and metals are used as moneycomodities that were easily divisible, handy to carry, immutableand involved low costs of storage and transportation

2 Paper Money

has became a more ecient way to trade - coins and notes incirculation with little or no intrinsic valueregulation by a central authority




Functions of Money

Money is defined in terms of the functions that it performs.

The traditional specification of these functions is:

1 Medium of exchange/payments.2 Store of value.3 Standard of deferred payments.4 Unit of account.




Money Supply

The money supply is the total amount of money available in aneconomy at a particular point in time (a stock).

Monetary aggregates:

1 M0 i.e, monetary base -sometimes called high powered money.2 M1 i.e, defined as currency in circulation plus demand deposits

held by the non-bank public in commercial banks.3 M2 = M1 plus savings deposits with unrestricted access and small-

denomination time deposits. These claims may not be instantlyliquid.

4 M3 = M2 plus large-denomination time-deposits

Notice that, definition of money have not become standardized,so that their definitions remain country specific.

As we move down the list, the liquidity of the added assetsdecrease, while their interest yield increases.




Money Demand

In macroeconomics the demand for money is considered as partof a portfolio allocation problem about how economic agentsallocate their financial wealth among the dierent existing assets,including money.

The portfolio decision involves a balance of considerations ofexpected rate of return after tax, risk, and liquidity.

The incorporation of a micro-founded money demand inmacromodels is often based on one or another kind of short-cut:

1 The cash-in-advance constraint2 The shopping-costs approach3 The money-in-the-utility function approach.4 The money-in-the-production-function approach.




Money Market

Money market is meant an abstract market place (not aphysical location) where at any particular moment the aggregatedemand for money meets the aggregate supply of money.

Aggregate demand for real money balances can be approximatedby the function L(Y , i), where LY > 0 and Li < 0

Let the monetary aggregate in focus be M1 and let P be thegeneral price level in the economy (say the GDP deflator)

Then money market equilibrium is:

M = PL(Y , i)

that is, the available amount of money equals nominal moneydemand.


Monetary EconomicsWhy do we Study Monetary EconomicsStylized Facts: Money and Economic Aggregates

The Concept of MoneyWhat is money and what does it do?Money Market

week 1 update foundations of monetary economics

Documents

monetary policy acts

growth rate of money

money growthand

definitions of money

faculty of economics

money growth andoutput

money andbusiness cycle

long run infation