PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 19 The Demand for Money

Copyright © 2004 South-Western. All rights reserved.19–2 Fundamental Issues 1.What is the Cambridge equation? 2.What are real money balances? 3.According to the inventory theory of the demand for money, what are the key factors influencing desired holdings of real money balances? 4.What do other transactions-related theories add to our understanding of the demand for money?

Copyright © 2004 South-Western. All rights reserved.19–3 Fundamental Issues (cont’d) 5.What theories explain the demand for real money balances based on money’s function as a store of value? 6.What difficulties do economists face in trying to predict the overall demand for money?

Copyright © 2004 South-Western. All rights reserved.19–4 The Motives for Holding Money Transactions motive:  The desire to hold currency and transactions deposits to use as media of exchange in planned transactions. Portfolio motive:  The desire to hold money as part of a strategy of balancing the expected rate of return on money with rates of return on other assets.

Copyright © 2004 South-Western. All rights reserved.19–5 The Demand for Money as a Medium of Exchange The Cambridge equation:  People use money assets to buy other goods and services, their demand for such assets as media of exchange depends on how many purchases they plan to make. This depends on their ability to spend, which in turn depends on their incomes.

Copyright © 2004 South-Western. All rights reserved.19–6 The Demand for Real Money Balances Real money balances:  The purchasing power of the quantity of money in circulation, measured as the nominal quantity of money divided by an index measure of the prices of goods and services.

Copyright © 2004 South-Western. All rights reserved.19–7 The Inventory Approach to the Demand for Money Inventory theory of money demand:  A theory of the demand for money that focuses on how people determine the best inventory of money to keep on hand.  Assumptions:  On-hand money bears no interest.  People earn a fixed amount of real income.  People buy goods and services at a constant rate.

Copyright © 2004 South-Western. All rights reserved.19–8 An Annual Spending Pattern with a Constant Rate of Spending Figure 19–1

Copyright © 2004 South-Western. All rights reserved.19–9 Alternative Spending Patterns Figure 19–2

Copyright © 2004 South-Western. All rights reserved.19–10 The Total Cost of Maintaining a Cash Inventory Figure 19–3

Copyright © 2004 South-Western. All rights reserved.19–11 Factors Influencing the Cost-Minimizing Number of Cash Conversions Figure 19–4

Copyright © 2004 South-Western. All rights reserved.19–12 Factors Affecting the Amount of Real Money Balances Real income:  A rise in real income causes an increase in the quantity money demanded. The interest rate:  An increase in the bond interest rate induces a reduction in the quantity of money demanded. The cash-conversion fee:  An increase in the cash-conversion fee causes an increase in the quantity of money demanded.

Copyright © 2004 South-Western. All rights reserved.19–13 Alternative Transaction-Based Theories of Money Demand Shopping-time theory of money demand:  A theory of the demand for money that focuses on money’s role in helping people reduce the amount of time they spend shopping, thereby freeing up more time for leisure or work. Cash-in-advance approach:  A theory of the demand for money based on the assumption that people must have real money balances in their possession before they can purchase any goods or services.

Copyright © 2004 South-Western. All rights reserved.19–14 The Portfolio Demand for Money The Keynesian portfolio demand for money:  Money, bonds, and financial wealth  The speculative motive  Interest rate expectations  Money demand and interest rates

Copyright © 2004 South-Western. All rights reserved.19–15 Money as a Social Store of Value The Overlapping-Generations approach to the demand for money:  A theory of money demand that emphasizes how societies use money as a way to store and transfer wealth across time.

Copyright © 2004 South-Western. All rights reserved.19–16 A Basic Overlapping-Generations Economy Figure 19–5

Copyright © 2004 South-Western. All rights reserved.19–17 A Money Demand Schedule Figure 19–6

Copyright © 2004 South-Western. All rights reserved.19–18 The Identification and Simultaneity Problems Identification problem:  The problem that economists face in evaluating whether real-world data are consistent with the downward-sloping money demand schedule that money demand theories predict, given the fact that both money demand and money supply vary over time.

Copyright © 2004 South-Western. All rights reserved.19–19 The Identification and Simultaneity Problems (cont’d) Simultaneity problem:  The problem of accounting for the possibility that factors influencing the quantity of money demanded are themselves affected by how many real money balances people hold, which can complicate assessments of how well real-world observations square with theories of money demand.

Copyright © 2004 South-Western. All rights reserved.19–20 The Identification Problem Figure19–7

Copyright © 2004 South-Western. All rights reserved.19–21 Estimated Income Elasticities of Money Demand Figure 19–9 SOURCE: Subramanian Sriram,“A Survey of Empirical Money Demand Studies,” IMF Staff Papers 47 (3,2000): 334–365.