Wealth creation Holding money (M1) at Zero interest

If nominal GDP is $300, at zero interest, and every dollar of income is spent – by definition M1 should be $300 and velocity will be one Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Transaction Demand

Wealth Generally, wealth is considered the accumulation of productive resources (the ownership of the “means of production”) to quote Marx. Productive resources generate income Money is not a productive resource, it produces zero income So why hold some of my wealth as money?

Holding money as wealth some of the functions and characteristics of m1 at play Money (m1) has a store of value Money (m1) is fungible A $50 note today is a $50 note next year Therefore there is no risk in holding on to the $50 note Therefore money is perfectly liquid – there is no transaction cost in making, the $50 you held, available for a transaction next year

So, why hold (save) wealth as money? Even if it generates no income- always paying zero interest?? Money is an attractive asset to be holding when the prices of goods services or other financial assets –are expected to decline –This is speculative asset demand Money is an attractive asset to be holding when income unexpectedly declines –This is precautionary asset demand

What’s all this about zero interest? What determines the interest rate? That is found in the Loanable funds market and is affected by the profit motive While the demand for loans may be infinite at zero cost to borrowers for –new physical capital –research and development –education –cars –trips No one is willing or able to supply the money for a loan, if no one is willing or able to pay for it

Why is zero interest important? At zero interest, there is no opportunity cost to holding money (m1) as an asset (holding money as wealth) So its back to our original graph and the formula MV=PQ Or PQ/M=V

If nominal GDP is $300, at zero interest, keeping output constant and every dollar of income is not spent – but $50 is held as asset demand (either precautionary or speculative) by definition M1 for transactions should be $250 and velocity will be 1.2 the $250 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is still $300 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand Transaction Demand

If nominal GDP is $300, at zero interest, keeping output constant and every dollar of income is not spent – but $100 is held as asset demand (either precautionary or speculative) by definition M1 for transactions should be $200 and velocity will be 1.5 the $200 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is still $300 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand Transaction Demand

If nominal GDP is $300, at zero interest, keeping output constant and every dollar of income is not spent – but $150 is held as asset demand (either precautionary or speculative) by definition M1 for transactions should be $150 and velocity will be 2 the $150 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is still $300 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand Transaction Demand

If nominal GDP is $300, at zero interest, keeping output constant and every dollar of income is not spent – but $200 is held as asset demand (either precautionary or speculative) by definition M1 for transactions should be $100 and velocity will be 3 - the $100 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is still $300 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand Transaction Demand

Now let us hold the velocity and output constant and let us add the interest rate! Suppose some are willing and able to pay interest in order to borrow The profit motive and opportunity cost take over The amount you are willing to hold at zero interest is reduced by the amount you are willing to risk and at the transaction cost of liquidity

If nominal GDP is $300, at 2.5% interest, keeping output constant and every dollar of income is not spent – but $150 is held as asset demand (either precautionary or speculative) and $50 is deposited as M2,by definition M1 for transactions should be $100 and velocity will be 3 - the $100 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is now $250 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand M2 savings Transaction Demand

If nominal GDP is $300, at 5% interest, keeping output constant and every dollar of income is not spent – but $100 is held as asset demand (either precautionary or speculative) and $100 is deposited as M2,by definition M1 for transactions should be $100 and velocity will be 3 - the $100 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is now $200 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand M2 savings Transaction Demand

If nominal GDP is $300, at 7.5% interest, keeping output constant and every dollar of income is not spent – but $50 is held as asset demand (either precautionary or speculative) and $150 is deposited as M2,by definition M1 for transactions should be $100 and velocity will be 3 - the $100 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is now $150 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand M2 savings Transaction Demand

If nominal GDP is $300, at 10% interest, keeping output constant and every dollar of income is not spent – but $0 is held as asset demand (either precautionary or speculative) and $200 is deposited as M2, by definition M1 for transactions should be $100 and velocity will be 3 - the $100 has to work harder (move more quickly through the economy) in the same time period – but the quantity of M1 demanded is now $100 Quantity of (M1) money demanded Interest Rate % 7.5% 5% 2.5% PQ Asset demand M2 savings Transaction Demand

Summation: MV=PQ The m in the formula is m1 for transactions only The v in the formula is the number of times in a year m1 for transactions is transferred through the economy The money supply always has to equal the combined transaction demand plus the asset demand for m1 The amount of m1 held as an asset is inversely related to the interest rate

Some notes At zero interest, banks provide checking accounts on a fee basis When banks can make a profit, because people are willing to pay interest, and banks are willing to take risk, checking accounts are provided on a free basis - often with rewards (a free toaster, in my day, mileage or overdraft forgiveness in yours) M2 increases the money supply because (if) –it is being recirculated as loans, within the economy –And (if) when the loans are being deposited into banks