Walras’ Walras’ Law

In an economy of n markets, when (n –1) markets clear, the nth market will also be in equilibrium equilibrium. Therefore, total supply of money and bonds, (MS + BS), must be bonds, equal to the total demand for money and bonds, (MD + BD), since bonds, people who are trying to sell bonds are trying to obtain money. money. Hence, or MS + BS = MD + BD (MD – MS) + (BD – BS) = 0

If there is an excess demand for money, there must be an excess supply of bonds.

Money Demand and Income Money Demand kY 0 Income SB/Macro .

Money Demand and Interest Rate 0 SB/Macro .

unforeseen medical bill).g. essentially of a transaction nature (e. • People hold money because they can't anticipate every need.Keynesian Theory of Money Demand The Precautionary Motive • Cash balances held in case of unforeseen outlays.. there is uncertainty. more SB/Macro . so they would like to hold more.

hence people would like to hold fewer bonds.Keynesian Theory of Speculative Demand for Money • Speculation = buying an asset in the hopes that its price will rise.. bond price falls. • Bond price varies inversely with interest rate. a bond. SB/Macro .e. if interest rate rises. Lower the interest rate.. lower the interest income from bonds. e.g. i.

Md 0 M SB/Macro .Equilibrium Interest Rate Combining demand for money with supply of money I N T E R E S T R A T E Ms controlled by RBI Stable eqlbn.

Expand supply of money to decrease interest rate Interest rate Ms controlled by RBI ↑ Ms ⇒ ↓ interest rate Md M SB/Macro .

Contract supply of money to increase interest rate Interest Rate Ms ↓ Ms ⇒ ↑ interest rate Md 0 M SB/Macro .

• Tight monetary policy refers to the RBI policies that contract the money supply in an effort to restrain the economy. • Easy monetary policy refers to the RBI policies that expand the money supply in an effort to stimulate the economy. SB/Macro .

Therefore. stock.The Classical View The Quantity Theory of Money MS × V = P × Y Money Supply × Velocity† = Price × Output Classicists assumed V and Y to be fixed. price level is proportional to the money stock. † It measures the rate at which money circulates in the economy economy. SB/Macro .

which controls the money supply.Thus. then price level will be stable. If the Central Bank stable. has ultimate control over inflation. the price level will rise rapidly. If the Central Bank keeps the money supply stable. SB/Macro . increases the money supply rapidly. the classical QTM states that the Central Bank.

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