TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or...
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Transcript of TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or...
![Page 1: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/1.jpg)
TM 13-1Copyright © 1998 Addison Wesley Longman, Inc.
What is Money?
• Money is any commodity or token that is generally acceptable as the means of payment.
• A means of payment is a method of settling a debt.
![Page 2: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/2.jpg)
TM 13-2Copyright © 1998 Addison Wesley Longman, Inc.
What Money Does?
• functions of Money
1) Medium of exchange
2) Unit of account
3) Store of value
![Page 3: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/3.jpg)
TM 13-3Copyright © 1998 Addison Wesley Longman, Inc.
Measures of Money?
• Official Measures of Money
1) M1 consists of currency and traveler’s checks plus checking deposits.
• Includes accounts held by individuals and businesses, but does not include currency held by banks, or currency and checking deposits owned by the U.S. government
![Page 4: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/4.jpg)
TM 13-4Copyright © 1998 Addison Wesley Longman, Inc.
Measures of Money?
• Official Measures of Money
2) M2 consists of M1 plus saving deposits and time deposits
![Page 5: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/5.jpg)
TM 13-5Copyright © 1998 Addison Wesley Longman, Inc.
Measures of Money?
• Official Measures of Money
3) M3 consists of M2 plus large-scale time deposits and term deposits
![Page 6: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/6.jpg)
TM 13-6Copyright © 1998 Addison Wesley Longman, Inc.
Two Measures of Money
![Page 7: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/7.jpg)
TM 13-7Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Financial intermediaries are firms that take deposits from households and firms and makes loans to other households and firms.
![Page 8: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/8.jpg)
TM 13-8Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Four Types of Financial Intermediaries
1) Commercial banks
2) Savings and loan associations
3) Savings banks and credit unions
4) Money market mutual funds
![Page 9: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/9.jpg)
TM 13-9Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Commercial Banks
• A commercial bank is a firm, licensed by the Comptroller of the Currency or by a state agency to receive deposits and make loans.
![Page 10: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/10.jpg)
TM 13-10Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Commercial Banks
• Their balance sheet is described by the following formula:
Liabilities + Net Worth = Assets
![Page 11: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/11.jpg)
TM 13-11Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Reserves and Loans
• Banks divide their funds into two parts:• Reserves are cash in a bank’s vault plus its deposits
at Federal Reserve banks
• Loans
![Page 12: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/12.jpg)
TM 13-12Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries
• Three Types of Assets Held by Banks
1) Liquid assets are U.S. government Treasury bills and commercial bills
2) Investment securities are longer-term U.S. government bonds and other bonds
3) Loans are commitments of fixed amounts of money for agreed- upon periods of time
![Page 13: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/13.jpg)
TM 13-13Copyright © 1998 Addison Wesley Longman, Inc.
Financial Intermediaries (FI)
• The Economic Functions of FI
1) Creating Liquidity
2) Minimizing the cost of borrowing
3) Minimizing the cost of monitoring borrowers
4) Pooling Risk
![Page 14: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/14.jpg)
TM 13-14Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Reserves: Actual and Required
• The reserve ratio is the fraction of a bank’s total deposits that are held in reserves.
• The required reserve ratio is the ratio of reserves to deposits that banks are required, by regulation, to hold.
• Excess reserves are actual reserves minus required reserves.
![Page 15: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/15.jpg)
TM 13-15Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Creating Deposits by Making loans in a One-Bank Economy
Let’s see an example of howbanks create money.
![Page 16: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/16.jpg)
TM 13-16Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $100 Deposits $400
Loans $300
Total $400 Total $400
Creating Money at theOne-and-Only Bank
Balance sheet on January 1
Assets(millions of dollars)
Liabilities(millions of dollars)
![Page 17: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/17.jpg)
TM 13-17Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $101 Deposits $401
Loans $300
Total $401 Total $401
Creating Money at theOne-and-Only Bank
Balance sheet on January 2
Assets(millions of dollars)
Liabilities(millions of dollars)
![Page 18: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/18.jpg)
TM 13-18Copyright © 1998 Addison Wesley Longman, Inc.
Reserves $101 Deposits $404
Loans $303
Total $404 Total $404
Creating Money at theOne-and-Only Bank
Balance sheet on January 3
Assets(millions of dollars)
Liabilities(millions of dollars)
![Page 19: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/19.jpg)
TM 13-19Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• The Deposit Multiplier
reservesinChange
depositsinChangemultiplierDeposit
![Page 20: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/20.jpg)
TM 13-20Copyright © 1998 Addison Wesley Longman, Inc.
How Banks Create Money
• Creating Deposits by Making Loans with Many Banks
Let’s see how the
banking system creates money
![Page 21: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/21.jpg)
TM 13-21Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
![Page 22: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/22.jpg)
TM 13-22Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
![Page 23: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/23.jpg)
TM 13-23Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000Loan
$75,000Reserve$25,000
![Page 24: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/24.jpg)
TM 13-24Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence
Deposit$100,000
Loan$75,000
Deposit$75,000
Reserve$25,000
The running tallyReserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000
![Page 25: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/25.jpg)
TM 13-25Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tally
Deposit$100,000
Reserves Loans Deposits
$25,000
$75,000 $25,000
$75,000 $100,000Loan
$75,000
Deposit$75,000
Reserve$25,000
Loan$56,250
Reserve$18,750 $43,750 $131,250 $175,000
![Page 26: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/26.jpg)
TM 13-26Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence
Deposit$56,250
The running tallyReserves Loans Deposits
![Page 27: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/27.jpg)
TM 13-27Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$43,750 $131,250 $175,000
Deposit$56,250
Loan$42,187
Reserve$14,063 $57,813 $173,437 $231,250
![Page 28: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/28.jpg)
TM 13-28Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
Deposit$56,250
Loan$42,187
Reserve$14,063
Deposit$42,187
$43,750 $131,250 $175,000
$57,813 $173,437 $231,250
![Page 29: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/29.jpg)
TM 13-29Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$68,360 $205,077 $273,437
Loan$31,640
Reserve$10,547
![Page 30: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/30.jpg)
TM 13-30Copyright © 1998 Addison Wesley Longman, Inc.
The Multiple Creationof Bank Deposits
The sequence The running tallyReserves Loans Deposits
$68,360 $205,077 $273,437
Loan$31,640
Reserve$10,547
andso on...
$100,000 $300,000 $400,000
![Page 31: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/31.jpg)
TM 13-31Copyright © 1998 Addison Wesley Longman, Inc.
The Fed controls the money supply by adjusting the reserves of the banking system.
![Page 32: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/32.jpg)
TM 13-32Copyright © 1998 Addison Wesley Longman, Inc.
The Fed controls the money supply by adjusting the reserves of the banking system. These reserves are controlled by three tools available to the Fed.
![Page 33: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/33.jpg)
TM 13-33Copyright © 1998 Addison Wesley Longman, Inc.
1) Required reserve ratios
![Page 34: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/34.jpg)
TM 13-34Copyright © 1998 Addison Wesley Longman, Inc.
1) Required reserve ratios
2) Discount rate
![Page 35: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/35.jpg)
TM 13-35Copyright © 1998 Addison Wesley Longman, Inc.
1) Required reserve ratios
2) Discount rate
3) Open market operations
![Page 36: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/36.jpg)
TM 13-36Copyright © 1998 Addison Wesley Longman, Inc.
• Required Reserve Ratios
• The Fed determines a required reserve ratio for each type of deposit.• In 1997, banks were required to keep 3 percent of
checking deposits up to $49 million and 10 percent of deposits in excess of $49 million.
• Other deposits had no reserve requirement.
![Page 37: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/37.jpg)
TM 13-37Copyright © 1998 Addison Wesley Longman, Inc.
• Discount Rate
• The discount rate is the interest rate at which the Fed stands ready to lend reserves to commercial banks.
![Page 38: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/38.jpg)
TM 13-38Copyright © 1998 Addison Wesley Longman, Inc.
• Open Market Operations
• Open market operations are the purchase or sale of government securities by the Federal Reserve System on the open market.
![Page 39: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/39.jpg)
TM 13-39Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• We are going to study the effect the money supply has on real GDP, the price level, and the inflation rate.
![Page 40: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/40.jpg)
TM 13-40Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Short-Run Effects of a Change in the Quantity of Money
• Let’s study how a change in the quantity of money effects these factors by examining the aggregate supply-aggregate demand model.
![Page 41: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/41.jpg)
TM 13-41Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
120
107
6.8 7.4
![Page 42: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/42.jpg)
TM 13-42Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
AD0
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 43: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/43.jpg)
TM 13-43Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
AD0
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 44: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/44.jpg)
TM 13-44Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
120
107
6.8 7.4
LAS
SAS
AD1
![Page 45: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/45.jpg)
TM 13-45Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
![Page 46: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/46.jpg)
TM 13-46Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
AD1
SAS1
![Page 47: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/47.jpg)
TM 13-47Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
![Page 48: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/48.jpg)
TM 13-48Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
![Page 49: TM 13-1 Copyright © 1998 Addison Wesley Longman, Inc. What is Money? Money is any commodity or token that is generally acceptable as the means of payment.](https://reader034.fdocuments.net/reader034/viewer/2022052603/56649eb05503460f94bb60c5/html5/thumbnails/49.jpg)
TM 13-49Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD1
SAS1
AD2
SAS2
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TM 13-50Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Effects ofChange in Quantity of Money
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
100
110
130
140
6.6 7.0 7.2 7.6
121
6.8 7.4
LAS
113
AD2
SAS2
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TM 13-51Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how banks create money
• Explain why the quantity of money is an important economic magnitude
• Explain the quantity theory of money
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TM 13-52Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Quantity Theory of Money
• The quantity theory of money is the proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level.
• This theory is based upon the velocity of circulation and the equation of exchange.
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TM 13-53Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The Quantity Theory of Money
• The velocity of circulation is the average number of times a dollar of money is used annually to buy goods and services that make up GDP.
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TM 13-54Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• GDP equals the price level (P) times real GDP (Y), or:
GDP = PY
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TM 13-55Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Make the quantity of money M, and the velocity of circulation V is determined by:
V = PY/M
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TM 13-56Copyright © 1998 Addison Wesley Longman, Inc.
The Velocity of Circulation in the United States: 1930–1996
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TM 13-57Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The equation of exchange states that the quantity of money (M) multiplied by the velocity of circulation (V) equals GDP, or
MV=PY
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TM 13-58Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• We can convert the equation of exchange into the quantity theory of money by making two assumptions:
1) The velocity of circulation is not influenced by the quantity of money.
2) Potential GDP is not influenced by the quantity of money.
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TM 13-59Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Assuming this is true, the equation of exchange tells us that a change in the quantity of money causes an equal proportional change in the price level.
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TM 13-60Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• This can be shown by using the equation of exchange to solve for the price level.
P = (V/Y)M
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TM 13-61Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• In the long run, real GDP equals potential GDP, so the relationship between the change in the price level and the quantity of money is:
MYVP )/(
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TM 13-62Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Dividing this equation by an earlier one, P = (V/Y)M, gives us
MMPP //
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TM 13-63Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• This equation shows that the proportionate change in the price level equals the proportionate change in the quantity of money.
• This gives us the quantity theory of money:
• In the long run, the percentage increase in the price level equals the percentage increase in the quantity of money.
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TM 13-64Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• The AS-AD model predicts the same outcome as the quantity theory of money.
• It also predicts a less precise relationship between the quantity of money and the price level in the short run than in the long run.
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TM 13-65Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Historical Evidence on the Quantity Theory of Money
• The data are broadly consistent with the quantity theory of money, but the relationship is not precise.
• The relationship is stronger in the long run than in the short run.
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TM 13-66Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the United States
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TM 13-67Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the United States
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TM 13-68Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the World Economy
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TM 13-69Copyright © 1998 Addison Wesley Longman, Inc.
Money Growth andInflation in the World Economy
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TM 13-70Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Correlation, Causation, and Other Influences
• The evidence shows that money growth and inflation are correlated.
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TM 13-71Copyright © 1998 Addison Wesley Longman, Inc.
Money, Real GDP, andthe Price Level
• Correlation, Causation, and Other Influences
• This does not represent causation.• Does money growth cause inflation, or does
inflation cause money growth?
• Does some other factor cause inflation (deficit spending)?