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Money represents the totality of means of exchange used directly and accepted by all members of community for regulation

of market transactions

Money functions
measure of value medium of exchange a store of value

Mass of money is the quantity of money in the circulation in a definite period of time

mass of money as stock

mass of money as flow

sum of the monetary assets holding by economic agents at a given moment

average quantity of money in the circulation in a definite period of time Mflow = Mstock x Vvelocity of money circulation

Concepts about Money

Rational concept => Money is the result of negociations between people (J.Galbraith, P.Samuelson) Evolutional concept => Money is the result of the evolution of Social division of labor and commodity exchange (K.Marx) Neoclassical concept => Fiat money => Money as specific(absolute) boon Keynesian concept => Money as the absolute liquidity asset Monetarist concept => Money has importance. Money is the financial asset and the component of Wealth. Modern Theory of Money => The nature of money is determined by its functions (Hiks, M.Macconnell, S.Brue)

Structure of money (assets)

Currency

Other assets (stocks, treasury bills)

credit money (bank deposits)

demand deposits

time deposits

currency deposits

Money Aggregates are various measures of the stock of money that exists in an economy. Major criteria : liquidity Income necessity M0 = currency (in R.Moldova, at31.12.2008 = 7578,7 mln.lei) M1 = M0 + demand deposits (checkable) (4030,5 mln.lei) => 11609,2 mln.lei M2 = M1 + time deposits (10148 + 16,9 mln.lei) M3 = M2 + foreign currency deposits (9906,7 mln.lei) => 21774,1 mln.lei => 31680,7 mln.lei

Money Base:

H = C + R

C currency R Required Reserves


(in 2008 > 11633,6 mln.lei)

The Demand of Money => Demand to hold money. To use money people must hold money

Determinants of M D are following :

N Number of transactions: where: M quantity of money demanded in a separate period of time; V velocity of money circulation; P general level of prices; Y national income (real).

Interest rate : Inflation rate : Expectations

Monetarist approach :
Demand for Money depends on the alternative replacement of the

financial assets.

where: Rs expected income on stocks; Rb expected income on bonds; e anticipated rate of inflation; w investment in human capital; u consumer preferences; y total wealth.

Supply of Money represents the quantity of money in the circulation (Sm), includes the currency and the Bank deposits :

M = C + D
Currency (coins and paper money) is issued by the Central (National) Bank Credit money (Bank deposits) is issued by the Commercial banks and thrift institutions

Mechanism of the creation of new money by the Commercial banks :

Commercial banks forme the required reserves from deposits. RR => the amount of money a bank must keep on deposit with the Central Bank. Central Bank creates the Money Base :

H =C +R

Actual reserves exceed the required reserves.

actual reserves required reserves = excess reserves K (excess reserves) = D


x

Lending ability of commercial bank is determined by excess reserves:

(1 rr)

where: rr required reserve ratio; D bank deposits

The commercial banking system can multiply the Excess reserves trough a mechanism called the money multiplayer : Mb indicates the multiple by which the banking system c can expand the money supply for each dollar (lei) of excess reserves.

The maximum amount (demand deposit expansion) of new credit money, which can be created by the banking system is equal : c Example: suppose

D = $1000, rr = 10%

; ;

or

initial injection currency Conclusion :

$1000

A. loan RR $100

$900

B. loan RR $90

$810

C. loan RR $81

$720

Easy and tight credit monetary policy: comparative analysis


Tight (contractionary) policy Major goal: decrease the Inflation Rate Dm > Sm
1. Open market operations 2. Discount rate change 3. Required reserve ratio change
P LRAS SRAS P2 P1 P2 B AD2 Y* Y1 A AD1 Y Y1 Y* AD1 Y P1 A AD2 B P LRAS SRAS

Tools

Easy (expansionary) policy Major goal: increase the Employment level trough r > I > Dm > Sm Central Bank purchases public bonds

Central Bank sells public bonds

Monetary aggregates in USA M 1 = currency + travelers checks + demand deposits +


other checkable deposits

M 2 = M 1 + retail money market mutual funds + savings and


small time deposits + overnight repurchase agreements

M 3 = M 2 + large time deposits + term repurchase

agreements + Eurodollars + institutional money market mutual funds

November 2000 ($ bln.) currency M1 522, 7 1091 (8% of M3)

M2 4887

M3 6955

Keynesian approach => Demand for money is determined by the behavior of economic agents (liquidity preference theory)

transactional motive

precautionary motive

Holding money as a medium of exchange to make payments


r Dmt

Holding money to meet unplanned expenditures and emergencies


r Dmp

Dmt M

Dmp M

Dmt = f( Y )

Dm p = f( Y )
speculative (asset) motive

Holding money as a store of value instead of other assets such as bank deposits, stocks and public bonds
r DmS Dm

Dms

Dm t, p M Total Demand for Money M

Dms = f( r )

Dm = f( Y , r )
r > move along curve Dm Y > Dm shifts or to the right or

r DmS

to the left

Credit - Monetary Policy => total sum of measures of the reglamentation of Money market by Central Bank

Ultimate Policy target :

price stability full employment of labor force national currency stability (fixed exchange rate) sustainable economic growth Interest rate The growth (or decrease) in money supply Exchange rate Inflation forecast controlling the issue of currency by Central Bank controlling the lending ability of commercial banks and thrift institutions

Intermediate targets :

Major goals :

Tools of Credit-monetary policy

open market operations

discount rate change

required reserve ratio change

Buying and selling government securities by the Central Bank

Specified minimum percentage of the deposit liabilities which a Commercial bank must keep on deposit at the Central Bank If the discount rate, will raise the lending ability of Commercial Banks will increase, Sm will raise and r will decrease Interest rate which the Central Bank charge on the loans they make to Commercial Banks

Credit-Money Policy in action : the transmission mechanism


The direct effect of Credit-Monetary policy is simply that an increase in the MS causes people to have excess money balances. The changes in the MS lead to changes in nominal GDP in the same direction. The indirect effect occurs through changes in the interest rate (r) (Keynesian approach)
A change in monetary policy A change in excess reserves A multiple change in SM A change in r A change in investment A multiple change in national income reserves

The transmission mechanism of easy monetary policy


r Sm1 r1 r2 M1 M2 A B Dm M Sm2 r1 r2 r I(r) P LRAS A B P2 P1 A AD1 AD2 Y B SRAS

I1

I2

Y1

Y*

a) Money market

b) Demand for Investment

c) Market of the goods and services

Sm1 r r1 A

Sm2 r r2 B

Sm2 B

Sm1

r2

Dm

r1

Dm

M1

M2

M2

M1

SM

SM

The Money market Equilibrium

r
Dm

Sm

10 7 5

100

150

200

Dm

Sm1

Sm2

r
Dm1

Dm2
E2

10 7 5

E1 E2

12 10 7 5 E1

100

150

200

M 100 150 200 M

Dm r
S m r Dm