Global Econ Ch 15

Aggregate REAL Money demand

L(R,Y), a demand to hold a certain amount of real purchasing power in the liquid form.

Equil. in the Money Market

The market always moves toward an interest rate at which the real money supply = aggregate real money demand. If there is initially an excess supply of money, the interest rate falls, and if there is initially an excess demand, it rises.

Money and the Exchange Rate in the Long-run

a permanent increase in a country's money supply causes a proportional long-run depreciation of its currency against foreign currencies. A permanent decrease in country's money supply causes a proportional long-run appreciation of its currency against foreign currencies.

Liquidity

a rise in the average value of transactions carried out by a household or firm causes its demand for money to rise.

relationship between Price level, P, and money supply, M^s

all else equal, an increase in a country's money supply causes a proportional increase in its price level. ex., money supply doubles to 2M^s but output and interest rate do not change, then price level must also double to 2P to maintain equilibrium in money market.

Opportunity Cost

amount sacrificed by taking one course of action rather than another.

Output and the Interest Rate

an increase in real output raises the interest rate, while a fall in real output lowers the interest rate, given the price level and money supply.

Money Supply & the Exchange Rate in Short-run

an increase in the country's money supply causes its currency to depreciate in the foreign exchange market, while a reduction in the money supply causes currency to appreciate.

US Money Supply and the Dollar/Euro Exchange Rate

an increase in the country's money supply causes its currency to depreciate in the foreign exchange market. An reduction in the country's money supply causes its currency to appreciate in the foreign exchange market.

Interest Rate

measures the opportunity cost of holding money rather than interest-bearing bonds. A rise in the interest rate raises the cost of holding money and causes money demand to fall.

Long-run equilibrium Price Level

value of P that satisfies P= M^s / L(R,Y) when the interest rate and output are at their long-run levels (levels consistent with full employment).

Exchange Rate Overshooting

when immediate response to a disturbance is great than its long-run response.

Long-run effects of Money Supply Changes

A permanent increase in the money supply causes a proportional increase in the price level's long-run value. In particular, if the economy is initially at full employment, a permanent increase in the money supply will eventually be followed by a proportional increase in the price level.

Demand for Money - Expected Return

A rise in the interest rate causes the demand for money to fall

Interest Rates and the Money Supply

An increase in the money supply lowers the interest rate, while a fall in the money supply raises the interest rate, given the price level and output.

ratio M^d / P

desired money holdings measured in terms of a typical reference basket of commodities - equals the amount of real purchasing power people want in liquid form [L(R,Y)]

Deflation

economy experiences deflation when price level is falling

Inflation

economy experiences inflation when price level is rising

Aggregate Money Demand, M^d

total demand for money by all households and firms in the economy; sum of all economy's individual money demands Ratio of M^d / P= L(R,Y) agg. money demand proportional to Price level, & where value of L(R,Y) falls when R rises, and rises when Y rises