Finc 402 - One PDF

Introduction: Overview of the Course
Overview of The Financial System and Some Basic Concepts

Tools of Monetary Policy
Demand for Money
FINC 402: MONETARY THEORY
Dr. Edward Asiedu
University of Ghana Business School,Department of Finance
Oce Hours: Fridays 11:00am - 12:00 noon (UGBS Main

Campus, S13)
Email: edasiedu@ug.edu.gh
Dr. Edward Asiedu Monetary Theory

Demand for Money
Outline
1 Introduction: Overview of the Course
Introduction
Role and Nature of Money
Functions of Money
Evolution of Payment System
Measuring Money
2 Overview of The Financial System and Some Basic Concepts
Financial Market
Central Banking and the Conduct of Monetary Policy
Money Supply
3 Tools of Monetary Policy
4 Demand for Money
Money Demand
Theories of Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
Why should Accountants and Financial Analysts be

interested in Monetary Theory
Majority of us are going to be working with nancial

institutions (Financial intermediaries, banks, insurance
companies, pension funds, mutual funds etc.).

Introduction
Functions of Money
Demand for Money
Measuring Money


Financial intermediaries: institutions that borrow funds from

people and give loans to others.

Introduction
Functions of Money
Demand for Money
Measuring Money



Banks: institutions that accept deposits and make loans.

Introduction
Functions of Money
Demand for Money
Measuring Money



Banks: institutions that accept deposits and make loans.
And therefore it is important to understand how nancial

institutions work.

Introduction
Functions of Money
Demand for Money
Measuring Money

Also, importantly, to understand the role of money in the

economy.

Introduction
Functions of Money
Demand for Money
Measuring Money


economy.
Money, also referred to as the money supply, is dened as

anything that is generally accepted in payment for goods or
services or in the repayment of debts.

Introduction
Functions of Money
Demand for Money
Measuring Money


economy.

Money plays a key role in generating business Cycles

(recessions and booms).

Introduction
Functions of Money
Demand for Money
Measuring Money


economy.

Money plays a key role in generating business Cycles

(recessions and booms).
Business Cycles are upward and downward movement of

aggregate output produced in the economy

Introduction
Functions of Money
Demand for Money
Measuring Money

Business cycles aect all of us in immediate and important

ways. When output is rising, for example, it is easier to nd a
good job; when output is falling, nding a good job might be
dicult.

Introduction
Functions of Money
Demand for Money
Measuring Money


dicult.
Thus, recession (unemployment) and economic booms aect

all of us.

Introduction
Functions of Money
Demand for Money
Measuring Money


dicult.
Thus, recession (unemployment) and economic booms aect

all of us.
Changes in the money supply impacts changes in aggregate

economic activity and ination.

Introduction
Functions of Money
Demand for Money
Measuring Money
Aims of the course
The three main aims of the course are:

To enhance students understanding of the role and nature of
money.

Introduction
Functions of Money
Demand for Money
Measuring Money
Aims of the course

money.
To enhance students understanding of the monetary and

nancial system.

Introduction
Functions of Money
Demand for Money
Measuring Money
Aims of the course

money.

nancial system.
To equip students with the knowledge to understand the

impact of monetary policy on an economy

Introduction
Functions of Money
Demand for Money
Measuring Money
Aims of the course

money.

nancial system.
To equip students with the knowledge to understand the

impact of monetary policy on an economy
Students should be able at the end to evaluate alternative

monetary policy rules.

Introduction
Functions of Money
Demand for Money
Measuring Money
Outline of the course
Introduction:
Barter and Early Exchange Systems

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:
Denition and Nature, Functions and Value of Money

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:
Introduction of Financial Institutions in Ghana

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:

Structure of Central Banks and the Reserve System

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:

Bank Reserves and the Money Supply

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:

Determinants of the Money Supply

Introduction
Functions of Money
Demand for Money
Measuring Money
Introduction:

Determinants of the Money Supply

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Keynesian Theories Precautionary,

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Transaction and Speculative Demand

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Income Velocity and the Quantity Theory of Money

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism
Supply of Money
Monetary and Fiscal policy in the Macroeconomy

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism
Supply of Money
Interest Rates

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism
Supply of Money
Interest Rates
Monetary and Targeting and Money Control

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism
Supply of Money
Interest Rates
Ination and Money

Introduction
Functions of Money
Demand for Money
Measuring Money

Demand for Money
Monetarism
Supply of Money
Interest Rates
Ination and Money
Financial Crisis and the role of the central bank

Introduction
Functions of Money
Demand for Money
Measuring Money
Background readings
Frederic S. Mishkin, The Economics of Money, Banking, and

Financial Markets, 7th or 9th edition (Addison Wesley: New
York).

Introduction
Functions of Money
Demand for Money
Measuring Money
Background readings
Frederic S. Mishkin, The Economics of Money, Banking, and

Financial Markets, 7th or 9th edition (Addison Wesley: New
York).
Walsh, Carl E. Monetary theory and policy. MIT press, 2010

Introduction
Functions of Money
Demand for Money
Measuring Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
What Is Money?

Introduction
Functions of Money
Demand for Money
Measuring Money
What Is Money?
Money has been dierent things at dierent times; however, it

has always been important to people and to the economy.

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Functions of Money
Demand for Money
Measuring Money
What Is Money?

To understand the eects of money on the economy, we must

understand exactly what money is.

Introduction
Functions of Money
Demand for Money
Measuring Money
What Is Money?

To understand the eects of money on the economy, we must

understand exactly what money is.
We will explore the functions of money, looking at why and

how it promotes economic eciency.

Introduction
Functions of Money
Demand for Money
Measuring Money

Meaning of Money?

Introduction
Functions of Money
Demand for Money
Measuring Money

Meaning of Money?
As the word money is used in everyday conversation, it can

mean many things, but to economists, it has a very specic
meaning.

Introduction
Functions of Money
Demand for Money
Measuring Money

Meaning of Money?

meaning.
Economists dene money (also referred to as the money

supply) as anything that is generally accepted in payment for
goods or services or in the repayment of debts.

Introduction
Functions of Money
Demand for Money
Measuring Money

Meaning of Money?

meaning.
Economists dene money (also referred to as the money

supply) as anything that is generally accepted in payment for
goods or services or in the repayment of debts.
Currency, consisting of cedi bills, euro bills, dollar bills and

coins, clearly ts this denition and is one type of money.
When most people talk about money, they're talking about
currency (paper money and coins).

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Functions of Money
Demand for Money
Measuring Money
Meaning of Money?

Introduction
Functions of Money
Demand for Money
Measuring Money
Meaning of Money?
To dene money merely as currency is much too narrow for

economists.

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Functions of Money
Demand for Money
Measuring Money
Meaning of Money?

economists.
Because cheques are also accepted as payment for purchases,

checking/current account deposits are considered money as
well.

Introduction
Functions of Money
Demand for Money
Measuring Money
Meaning of Money?

economists.
Because cheques are also accepted as payment for purchases,

checking/current account deposits are considered money as
well.
An even broader denition of money is often needed, because

other items such as savings deposits can in eect function as
money if they can be quickly and easily converted into
currency or checking/current account deposits.

Introduction
Functions of Money
Demand for Money
Measuring Money
Meaning of Money?

Introduction
Functions of Money
Demand for Money
Measuring Money
Meaning of Money?
To complicate matters further, the word money is frequently

used synonymously with wealth. When people say, Mike is
richhe has an awful lot of money, they probably mean that
Mike has not only a lot of currency and a high balance in his
checking account but has also stocks, bonds, four cars, three
houses, and a yacht.

Introduction
Functions of Money
Demand for Money
Measuring Money
Meaning of Money?
To complicate matters further, the word money is frequently

used synonymously with wealth. When people say, Mike is
richhe has an awful lot of money, they probably mean that
Mike has not only a lot of currency and a high balance in his
checking account but has also stocks, bonds, four cars, three
houses, and a yacht.
Thus while currency is too narrow a denition of money, this

other popular usage is much too broad.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Whether money is kola or shells or rocks or gold or paper, it

has three primary functions in any economy:
Medium of Exchange

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money

Medium of Exchange
Unit of account

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money

Medium of Exchange
Unit of account
Store of value

Introduction
Functions of Money
Demand for Money
Measuring Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
In almost all market transactions in our economy, money in the

form of currency or checks is a medium of exchange; it is used
to pay for goods and services.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

The use of money as a medium of exchange promotes

economic eciency by minimizing the time spent in
exchanging goods and services.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange


HOW??

Introduction
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Demand for Money
Measuring Money
Functions of Money
Medium of Exchange


HOW??
Use the scenario of a Finance/Economics Professor, who can

do just one thing well: give brilliant monetary theory lectures.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
In a barter economy, if the Professor wants to eat, she must

nd a farmer who not only produces the food he likes but also
wants to learn economics. As you might expect, this search
will be dicult and time-consuming, and Ellen might spend
more time looking for such an economics-hungry farmer than
she will be teaching.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
In a barter economy, if the Professor wants to eat, she must

nd a farmer who not only produces the food he likes but also
wants to learn economics. As you might expect, this search
will be dicult and time-consuming, and Ellen might spend
more time looking for such an economics-hungry farmer than
she will be teaching.
It is even possible that she will have to quit lecturing and go

into farming herself. Even so, she may still starve to death.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
The time spent trying to exchange goods or services is called a

transaction cost.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

transaction cost.
In a barter economy, transaction costs are high because people

have to satisfy a double coincidence of wantsthey have to
nd someone who has a good or service they want and who
also wants the good or service they have to oer.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

transaction cost.
In a barter economy, transaction costs are high because people

have to satisfy a double coincidence of wantsthey have to
nd someone who has a good or service they want and who
also wants the good or service they have to oer.
The use of money as a medium of exchange there promotes


Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
For a commodity to function eectively as money, it has to
meet several criteria:
It must be easily standardized, making it simple to ascertain its
value;

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
value;
It must be widely accepted;

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
value;
It must be divisible, so that it is easy to make change;

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
value;
It must be easy to carry; and

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
value;
It must not deteriorate quickly.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Medium of Exchange
value;
It must not deteriorate quickly.
Examples of money (in history): Tobacco, whiskey, cigarettes

used in prisoner-of-war camps, beads etc.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
The second role of money is to provide a unit of account; that

is, it is used to measure value in the economy. We measure
the value of goods and services in terms of money.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account

Just as we measure weight in terms of kilograms or distance in

terms of kilometers.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account

Just as we measure weight in terms of kilograms or distance in

terms of kilometers.
To see why this function is important, let's look again at a

barter economy where money does not perform this function.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
If the economy has only three goodssay, Plantain, books,
and pensthen we need to know the price (value) of a kilo of
plantain in terms of books or pens. In other words, how many
kilos of plantain you have to pay for a book or penor how
many books (exercise book, textbook etc.) you have to pay for
a pen.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
a pen.
This will indeed become more complicated with more than

three goods.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
a pen.
This will indeed become more complicated with more than

three goods.
The solution to the problem is to introduce money into the

economy and have all prices quoted in terms of units of that
money

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
We can see that using money as a unit of account reduces

transaction cost

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Unit of Account
We can see that using money as a unit of account reduces

transaction cost
The benets of this function of money grow as the economy

becomes more complex.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value
Money also functions as a store of value; it is a repository of

purchasing power over time.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

A store of value is used to save purchasing power from the

time income is received until the time it is spent.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

A store of value is used to save purchasing power from the

time income is received until the time it is spent.
This function of money is useful, because most of us do not

want to spend our income immediately upon receiving it, but
rather prefer to wait until we have the time or the desire to
shop.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value
Money is not unique as a store of value; any assetwhether

money, stocks, bonds, land, houses, art, or jewelrycan be
used to store wealth.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Many such assets have advantages over money as a store of

value: They often pay the owner a higher interest rate than
money, experience price appreciation, and deliver services such
as providing a roof over one's head.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Many such assets have advantages over money as a store of

value: They often pay the owner a higher interest rate than
money, experience price appreciation, and deliver services such
as providing a roof over one's head.
Question: If these assets are a more desirable store of value

than money, why do people hold money at all?

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value
The answer to this question relates to the important economic

concept of liquidity, the relative ease and speed with which an
asset can be converted into a medium of exchange.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Liquidity is highly desirable. Money is the most liquid asset of

all because it is the medium of exchange; it does not have to
be converted into anything else in order to make purchases.
Other assets involve transaction costs when they are converted
into money.

Introduction
Functions of Money
Demand for Money
Measuring Money
Functions of Money
Store of Value

Liquidity is highly desirable. Money is the most liquid asset of

all because it is the medium of exchange; it does not have to
be converted into anything else in order to make purchases.
Other assets involve transaction costs when they are converted
into money.
Examples?

Introduction
Functions of Money
Demand for Money
Measuring Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
Evolution of the Payments System
We can obtain a good picture of the functions of money and

the forms it has taken over time by looking at the evolution of
the payments system, the method of conducting transactions
in the economy.

Introduction
Functions of Money
Demand for Money
Measuring Money
We can obtain a good picture of the functions of money and

the forms it has taken over time by looking at the evolution of
the payments system, the method of conducting transactions
in the economy.
Commodity Money
An object that clearly has value to everyone is a likely
candidate to serve as money, and a natural choice is a precious
metal such as gold or silver. Money made up of precious metals
or another valuable commodity is called commodity money.

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Demand for Money
Measuring Money

Fiat Money
The next development in the payments system was paper
currency (pieces of paper that function as a medium of
exchange).

Introduction
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Demand for Money
Measuring Money

Fiat Money
exchange).
Fiat money: paper money decreed by governments as legal

tender.

Introduction
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Demand for Money
Measuring Money

Fiat Money
exchange).

tender.
Major drawbacks of paper currency and coins are that they are
easily stolen and can be expensive to transport in large
amounts because of their bulk.

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Demand for Money
Measuring Money

Fiat Money
exchange).

tender.
Major drawbacks of paper currency and coins are that they are
easily stolen and can be expensive to transport in large
amounts because of their bulk.
To combat this problem, another step in the evolution of the

payments system occurred with the development of modern
banking: the invention of cheques.

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Demand for Money
Measuring Money
Cheques
an instruction to your bank to transfer money from your
account

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Demand for Money
Measuring Money
Cheques
account
Cheques allow transactions to take place without the need to

carry around large amounts of currency. The introduction of
cheques was a major innovation that improved the eciency of
the payments system.

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Functions of Money
Demand for Money
Measuring Money
Cheques
account
Cheques allow transactions to take place without the need to

carry around large amounts of currency. The introduction of
cheques was a major innovation that improved the eciency of
the payments system.
There are, however, two problems with a payments system

based on cheques. First, it takes time to get cheques from one
place to another, a particularly serious problem if you are
paying someone in a dierent location who needs to be paid
quickly.

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Demand for Money
Measuring Money
Cheques

Introduction
Functions of Money
Demand for Money
Measuring Money
Cheques
In addition, if you have a current account, it usually takes

several business days before a bank will allow you to make use
of the funds from a cheque you have deposited.

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Demand for Money
Measuring Money
Cheques

Electronic Payment

Introduction
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Demand for Money
Measuring Money
Cheques

Electronic Payment
e.g. online bill pay

Introduction
Functions of Money
Demand for Money
Measuring Money
Cheques

Electronic Payment
e.g. online bill pay
Necessitated by the development of inexpensive computers and

the spread of the Internet.

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Demand for Money
Measuring Money
E-Money (electronic money):

Electronic money (or e-money), is money that exists only in
electronic form. The rst form of e-money was the debit card
or bank card as usually called in Ghana.

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Demand for Money
Measuring Money

Debit cards or bank cards enable consumers to purchase goods

and services by electronically transferring funds directly from
their bank accounts to a merchant's account.

Introduction
Functions of Money
Demand for Money
Measuring Money

Debit cards or bank cards enable consumers to purchase goods

and services by electronically transferring funds directly from
their bank accounts to a merchant's account.
At most supermarkets, for example, you can swipe your debit

card through the card reader at the checkout station, press a
button, and the amount of your purchases is deducted from
your bank account.

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Demand for Money
Measuring Money

Introduction
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Demand for Money
Measuring Money
Debit or bank card

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Demand for Money
Measuring Money
Debit or bank card
Stored-value card (smart card)

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Demand for Money
Measuring Money
Debit or bank card
Stored-value card (smart card)
E-cash

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Demand for Money
Measuring Money
Are We Headed for a Cashless Economy?
Predictions of a cashless society have been around for decades,

but they have not come to fruition

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Demand for Money
Measuring Money

Although e-money might be more convenient and ecient

than a payments system based on paper, several factors work
against the disappearance of the paper system

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Functions of Money
Demand for Money
Measuring Money

Although e-money might be more convenient and ecient

than a payments system based on paper, several factors work
against the disappearance of the paper system
Still, the use of e-money will likely still increase in the future.

Introduction
Functions of Money
Demand for Money
Measuring Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
How do we measure money? Which particular assets can be

called money?

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Demand for Money
Measuring Money
Measuring Money

called money?
Central banking authority responsible for monetary policy has

conducted many studies on how to measure money.

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Demand for Money
Measuring Money
Measuring Money

called money?
Central banking authority responsible for monetary policy has

conducted many studies on how to measure money.
The problem of measuring money has recently become

especially crucial because extensive nancial innovation has
produced new types of assets that might properly belong in a
measure of money.

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Demand for Money
Measuring Money
Measuring Money
Central banks in many countries have modied their measures

of money several times and has settled on the following
measures of the money supply, which are also referred to as
monetary aggregates.

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Demand for Money
Measuring Money
Measuring Money

Construct monetary aggregates using the concept of liquidity:.

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Demand for Money
Measuring Money
Measuring Money

Construct monetary aggregates using the concept of liquidity:.
M1 or Narrow money (most liquid assets) = currency +

traveler's checks + demand deposits + other checkable
deposits.

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Demand for Money
Measuring Money
Measuring Money
M2 or broad money (adds to M1 other assets that are not so

liquid) = M1 + small denomination time deposits + savings
deposits and money market deposit accounts + money market
mutual fund shares.

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Demand for Money
Measuring Money
Measuring Money
M2 or broad money (adds to M1 other assets that are not so

liquid) = M1 + small denomination time deposits + savings
deposits and money market deposit accounts + money market
mutual fund shares.
In Ghana there is also M2+ which is M2 plus foreign currency

deposits

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Demand for Money
Measuring Money
Measuring Money
Table 1 Measures of the Monetary Aggregates.

Introduction
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Demand for Money
Measuring Money
Measuring Money
Table 1 Measures of the Monetary Aggregates.

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Demand for Money
Measuring Money
Measuring Money
M1 vs M2

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Demand for Money
Measuring Money
Measuring Money
M1 vs M2
Does it matter which measure of money is considered?

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Demand for Money
Measuring Money
Measuring Money
M1 vs M2
M1 and M2 can move in dierent directions in the short run

(see gure).

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
M1 vs M2
M1 and M2 can move in dierent directions in the short run

(see gure).
Conclusion: the choice of monetary aggregate is important for

policymakers.

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Where are all the Cedi and who is holding them?

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Criminals

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Criminals
Foreigners

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Figure 1 Growth Rates of the M1 and M2 Aggregates,
19602011.

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Figure 1 Growth Rates of the M1 and M2 Aggregates,
19602011.

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Figure 2: Broad Money for Ghana, 20052016.

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Figure 2: Broad Money for Ghana, 20052016.

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Q1: There are three goods produced in an econmy by three

indivduals:

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money

indivduals:
Goods Producer
Apples Orchard Owner

Bananas Banana grower
Chocolate Chocolatier

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money

indivduals:
Goods Producer
Apples Orchard Owner

Bananas Banana grower
Chocolate Chocolatier
If the orachard owner likes only bananas, the banana grower

likes only chocolate, and the chocolatier likes only apples will
any trade between these three persons take place in the barter
economy? How will the introducing money into the economy
benet these three producers?

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Where are all the money and who is holding them

Criminals

Introduction
Functions of Money
Demand for Money
Measuring Money
Measuring Money
Where are all the money and who is holding them

Criminals
Foreigners

Financial Market
Money Supply
Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Financial Market
Money Supply
Demand for Money
The Bond Market and Interest Rates
A security (nancial instrument) is a claim on the issuer's

future income or assets.

Financial Market
Money Supply
Demand for Money

A bond is a debt security that promises to make payments

periodically for a specied period of time.

Financial Market
Money Supply
Demand for Money

A bond is a debt security that promises to make payments

periodically for a specied period of time.
An interest rate is the cost of borrowing or the price paid for

the rental of funds

Financial Market
Money Supply
Demand for Money
The Stock Market
Common stock represents a share of ownership in a corporation

Financial Market
Money Supply
Demand for Money
The Stock Market
Common stock represents a share of ownership in a corporation
A share of stock is a claim on the residual earnings and assets

of the corporation

Financial Market
Money Supply
Demand for Money
Money, Business Cycles and Ination
The aggregate price level is the average price of goods and

services in an economy

Financial Market
Money Supply
Demand for Money

A continual rise in the price level (ination) aects all

economic players

Financial Market
Money Supply
Demand for Money

A continual rise in the price level (ination) aects all

economic players
Data shows a connection between the money supply and the

price level

Financial Market
Money Supply
Demand for Money
Figure 5 Average Ination Rate Versus Average Rate of

Money Growth for Selected Countries, 2000-2010

Financial Market
Money Supply
Demand for Money
Money and Interest Rates
Interest rates are the price of money

Financial Market
Money Supply
Demand for Money
Prior to1980,the rate of money growth and the interest rate on

long-term Treasury bonds were closely tied

Financial Market
Money Supply
Demand for Money
Prior to1980,the rate of money growth and the interest rate on

long-term Treasury bonds were closely tied
Since then,the relationship is less clear but the rate of money

growth is still an important determinant of interest rates

Financial Market
Money Supply
Demand for Money
The Foreign Exchange Market
The foreign exchange market is where funds are converted

from one currency into another

Financial Market
Money Supply
Demand for Money

The foreign exchange rate is the price of one currency in terms

of another currency

Financial Market
Money Supply
Demand for Money

The foreign exchange rate is the price of one currency in terms

of another currency
The foreign exchange market determines the foreign exchange

rate

Financial Market
Money Supply
Demand for Money
Fiscal Policy and Monetary Policy
Monetary policy is the management of the money supply and

interest rates
Conducted by the Central Bank(Bank of Ghana)

Financial Market
Money Supply
Demand for Money

interest rates
Fiscal policy deals with government spending and taxation

Budget decit is the excess of expenditures over revenues for a
particular year

Financial Market
Money Supply
Demand for Money

interest rates

particular year
Budget surplus is the excess of revenues over expenditures for

a particular year

Financial Market
Money Supply
Demand for Money

interest rates

particular year
Budget surplus is the excess of revenues over expenditures for

a particular year
Any decit must be nanced by borrowing

Financial Market
Money Supply
Demand for Money
Function of Financial Markets
Perform the essential function of channeling funds from

economic players that have saved surplus funds to those that
have a shortage of funds

Financial Market
Money Supply
Demand for Money
Function of Financial Markets
Perform the essential function of channeling funds from

economic players that have saved surplus funds to those that
have a shortage of funds
Direct nance: borrowers borrow funds directly from lenders

in nancial markets by selling them securities

Financial Market
Money Supply
Demand for Money
Function of Financial Markets (cont'd)
Promotes economic eciency by producing an ecient

allocation of capital, which increases production

Financial Market
Money Supply
Demand for Money
Function of Financial Markets (cont'd)
Promotes economic eciency by producing an ecient

allocation of capital, which increases production
Directly improve the well-being of consumers by allowing them

to time purchases better

Financial Market
Money Supply
Demand for Money
Figure 1 Flows of Funds Through the Financial System

Financial Market
Money Supply
Demand for Money
Structure of Financial Markets
Debt and Equity Markets

Debt instruments (maturity)

Financial Market
Money Supply
Demand for Money

Equities (dividends)

Financial Market
Money Supply
Demand for Money

Primary and Secondary Markets

Investment Banks underwrite securities in primary markets

Financial Market
Money Supply
Demand for Money

Primary and Secondary Markets

Investment Banks underwrite securities in primary markets
Brokers and dealers work in secondary markets

Financial Market
Money Supply
Demand for Money
Structure of Financial Markets (cont'd)
Exchanges and Over-the-Counter (OTC) Markets

Exchanges: NYSE, Chicago Board of Trade

Financial Market
Money Supply
Demand for Money

OTC Markets: Foreign exchange, Federal funds

Financial Market
Money Supply
Demand for Money

Money and Capital Markets

Money markets deal in short-term debt instruments

Financial Market
Money Supply
Demand for Money

Money and Capital Markets

Money markets deal in short-term debt instruments
Capital markets deal in longer-term debt and equity

instruments

Financial Market
Money Supply
Demand for Money
Table 1 Principal Money Market Instruments

Financial Market
Money Supply
Demand for Money
Table 2 Principal Capital Market Instruments

Financial Market
Money Supply
Demand for Money
Internationalization of Financial Markets
Foreign Bonds: sold in a foreign country and denominated in

that country's currency

Financial Market
Money Supply
Demand for Money

Eurobond: bond denominated in a currency other than that

of the country in which it is sold

Financial Market
Money Supply
Demand for Money


Eurocurrencies: foreign currencies deposited in banks outside

the home country
Eurodollars: U.S. dollars deposited in foreign banks outside the
U.S. or in foreign branches of U.S. banks

Financial Market
Money Supply
Demand for Money


Eurocurrencies: foreign currencies deposited in banks outside

the home country
Eurodollars: U.S. dollars deposited in foreign banks outside the
U.S. or in foreign branches of U.S. banks
World Stock Markets

Also help nance the federal government

Financial Market
Money Supply
Demand for Money
Function of Financial Intermediaries: Indirect Finance
Lower transaction costs (time and money spent in carrying out

nancial transactions)
Economies of scale

Financial Market
Money Supply
Demand for Money

Economies of scale
Liquidity services

Financial Market
Money Supply
Demand for Money

Economies of scale
Liquidity services
Reduce the exposure of investors to risk

Risk Sharing (Asset Transformation)

Financial Market
Money Supply
Demand for Money

Economies of scale
Liquidity services
Reduce the exposure of investors to risk

Risk Sharing (Asset Transformation)
Diversication

Financial Market
Money Supply
Demand for Money

(cont'd)
Deal with asymmetric information problems

(before the transaction) Adverse Selection:try to avoid
selecting the risky borrower

Financial Market
Money Supply
Demand for Money

(cont'd)

Gather information about potential borrower.

Financial Market
Money Supply
Demand for Money

(cont'd)

(after the transaction)Moral Hazard:ensure borrower will not

engage in activities that will prevent him/her to repay the loan.

Financial Market
Money Supply
Demand for Money

(cont'd)

(after the transaction)Moral Hazard:ensure borrower will not

engage in activities that will prevent him/her to repay the loan.
Sign a contract with restrictive covenants

Financial Market
Money Supply
Demand for Money

(cont'd)
Conclusion:

Financial Market
Money Supply
Demand for Money

(cont'd)
Conclusion:
Financial intermediaries allow smallsavers and borrowers to

benet from the existence of nancial markets

Financial Market
Money Supply
Demand for Money
Table 3 Primary Assets and Liabilities of Financial

Intermediaries

Financial Market
Money Supply
Demand for Money
Table 4 Principal Financial Intermediaries and Value of

Their Assets

Financial Market
Money Supply
Demand for Money
Regulation of the Financial System
To increase the information available to investors:

Reduce adverse selection and moral hazard problems

Financial Market
Money Supply
Demand for Money
Regulation of the Financial System
To increase the information available to investors:

Reduce adverse selection and moral hazard problems
Reduce insider trading (SEC).

Financial Market
Money Supply
Demand for Money
Regulation of the Financial System (cont'd)
To ensure the soundness of nancial intermediaries:

Restrictions on entry (chartering process)

Financial Market
Money Supply
Demand for Money

.
Disclosure of information.

Financial Market
Money Supply
Demand for Money

.
Restrictions on Assets and Activities (control holding of risky

assets).

Financial Market
Money Supply
Demand for Money

.

assets).
Deposit Insurance (avoid bank runs).

Financial Market
Money Supply
Demand for Money

.

assets).
Limits on Competition (mostly in the past)

Financial Market
Money Supply
Demand for Money

.

assets).
Branching

Financial Market
Money Supply
Demand for Money

.

assets).
Branching
Restrictions on Interest Rates

Financial Market
Money Supply
Demand for Money
Table 5 Principal Regulatory Agencies of the U.S. Financial

System

Financial Market
Money Supply
Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Financial Market
Money Supply
Demand for Money
Origins of the Central Bank( Bank of Ghana
The principal objects of the new central bank, as enshrined in

the 1957 Ordinance,

Financial Market
Money Supply
Demand for Money
Origins of the Central Bank( Bank of Ghana
The principal objects of the new central bank, as enshrined in

the 1957 Ordinance,
Were "to issue and redeem bank notes and coins: to keep and
use reserves and to inuence the credit situation with a view
to maintaining monetary stability in Ghana and the external
value of the Ghana pound; and to act as banker and nancial
adviser to the Government.

Financial Market
Money Supply
Demand for Money
Functions of the Central Bank of Ghana
Formulate and implement monetary policy aimed at achieving

the objects of the Bank;

Financial Market
Money Supply
Demand for Money

Promote by monetary measure the stablisation of the value of

the currency within and outside Ghana;

Financial Market
Money Supply
Demand for Money


Institute measures which are likely to have a favourable eect

on the balance of payments, the state of public nances and
the general development of the national economy;

Financial Market
Money Supply
Demand for Money


Institute measures which are likely to have a favourable eect

on the balance of payments, the state of public nances and
the general development of the national economy;
Regulate, supervise and direct the banking and credit system

and ensure the smooth operation of the nancial sector;

Financial Market
Money Supply
Demand for Money
License, regulate, promote and supervise non-banking nancial

institutions;

Financial Market
Money Supply
Demand for Money

institutions;
Act as banker and nancial adviser to the Government;

Financial Market
Money Supply
Demand for Money

institutions;
Promote and maintain relations with international banking and

nancial institutions and subject to the Constitution or any
other relevant enactment, implement international monetary
agreements to which Ghana is party; and

Financial Market
Money Supply
Demand for Money

institutions;
Promote and maintain relations with international banking and

nancial institutions and subject to the Constitution or any
other relevant enactment, implement international monetary
agreements to which Ghana is party; and
Do all other things that are incidental or conducive to the

ecient performance of its functions under this Act and any
other enactment

Financial Market
Money Supply
Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Financial Market
Money Supply
Demand for Money
Money Supply
The supply of money in an economy is determined by the

banking system
Directly controlled by the central bank through monetary
policy

Financial Market
Money Supply
Demand for Money
Money Supply

banking system
policy
Indirectly inuenced by commercial banks (and the public)

through the deposit creation process

Financial Market
Money Supply
Demand for Money
Money Supply

banking system
policy
Indirectly inuenced by commercial banks (and the public)

through the deposit creation process
The Central Bank controls the supply of money through the

conduct of monetary policy

Financial Market
Money Supply
Demand for Money
Money Supply
Central banks are responsible to conducting monetary policy

Financial Market
Money Supply
Demand for Money
Money Supply
In some countries, the central bank is independent of the

central government to conduct monetary policy

Financial Market
Money Supply
Demand for Money
Money Supply

Recall that monetary policy refers to changes in a country's

stock of money supply that seeks to stabilize the level of
economic activity and price level

Financial Market
Money Supply
Demand for Money
Money Supply


In most advanced countries, stable prices means ination rate

very close to 2%

Financial Market
Money Supply
Demand for Money
Money Supply


In most advanced countries, stable prices means ination rate

very close to 2%
And output as close as possible to the full employment level of

output

Financial Market
Money Supply
Demand for Money
Supply of Money
We will take the supply of money as a policy variable

Financial Market
Money Supply
Demand for Money
Supply of Money
We will take the supply of money as a policy variable
That is, the supply of money is the level determined by central

bank

Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Demand for Money
Central banks usually have an array instruments for conducting

monetary policy

Demand for Money

monetary policy
The main ones are:

Open market operations (OMO)

Demand for Money

monetary policy
The main ones are:

Reserve requirement policy

Demand for Money

monetary policy
The main ones are:

Reserve requirement policy
Discount rate policy

Demand for Money
Open Market Operations (1)
Open market operations (OMO) refer to the purchase or sale

of government securities in the open market

Demand for Money

The open market here refers to dealers in government bonds

and individuals government securities are government
bonds/treasury bills

Demand for Money

The open market here refers to dealers in government bonds

and individuals government securities are government
bonds/treasury bills
Open market purchases (sales) are meant to increase (reduce)

the money supply

Demand for Money

To see how OMO aects the money supply, consider open
market purchase of government securities worth GHC 100m

Demand for Money

The central banks issues the initial a check worth GHC 100m
which can be drawn as cash or deposited into an account with
a commercial bank

Demand for Money

a commercial bank
Note that either of these actions will increase the money

supply If the check is deposited in an account, the commercial
bank can creat additional loans out of it, increasing the money
supply further

Demand for Money

a commercial bank
Note that either of these actions will increase the money

supply If the check is deposited in an account, the commercial
bank can creat additional loans out of it, increasing the money
supply further
An open market sale will have the opposite eect on the

money supply

Demand for Money
In Ghana the Bank of Ghana's Monetary Policy Committee

announces the direction of monetary policy after its monthly
meeting

Demand for Money

meeting
In general the policy is announced as a target policy interest

rate

Demand for Money

meeting

rate
In Ghana, the monetary policy rate in the US,the federal funds

rate

Demand for Money

meeting

rate
In Ghana, the monetary policy rate in the US,the federal funds

rate
Open market activities are then carried out to meet the target
policy rate

Demand for Money
Advantages of Open Market Operations
The Central Bank(Bank of Ghana) has complete control over

the volume

Demand for Money

the volume
Flexible and precise

Demand for Money

the volume
Easily reversed

Demand for Money

the volume
Easily reversed
Quickly implemented

Demand for Money
Discount Rate
Commercials banks can borrow from central banks when they

are short of reserves

Demand for Money
Discount Rate

The interest rate charged on commercial banks borrowing from

the central bank is the discount rate (id )

Demand for Money
Discount Rate

The interest rate charged on commercial banks borrowing from

the central bank is the discount rate (id )
Central banks raise (lower) the discount rate to signal

tightening (loosening) of monetary policy

Demand for Money
Reserve Requirements
For the purposes of prudence commercial banks keep a small
fraction of their deposits as cash or its close equivalent to pay
depositors who desire to withdraw

Demand for Money
Part of these reserves are required by regulators (central banks)

Demand for Money
The required reserve ratio is the fraction of deposits required

by banks to keep as reserves

Demand for Money

Banks may in addition to the required reserves, keep additional

excess reserves

Demand for Money

Banks may in addition to the required reserves, keep additional

excess reserves
An increase in the required reserve ratio signals a tightening of

monetary policy

Demand for Money
Disadvantages of Reserve Requirements
No longer binding for most banks

Demand for Money
Can cause liquidity problems

Demand for Money
Can cause liquidity problems
Increases uncertainty for banks

Demand for Money
The Market for Reserves
To derive the demand curve for reserves, we need to ask what

happens to the quantity of reserves demanded, holding every
thing else constant, as the Policy rate changes.

Demand for Money

The amount of reserves can be split up into two components:

(1)required reserves, which equal the required reserve ratio
times the amount of deposits on which reserves are required,
and

Demand for Money


and
(2) excess reserves, the additional reserves banks choose to

hold.

Demand for Money


and
(2) excess reserves, the additional reserves banks choose to

hold.
Therefore, the quantity of reserves demanded equals required

reserves plus the quantity of excess reserves demanded.

Demand for Money
The Market for Reserves and Discount Rate
Demand and Supply in the Market for Reserves

Demand for Money
What happens to the quantity of reserves demanded by banks,

holding everything else constant, as the federal funds rate
changes?

Demand for Money

changes?
Excess reserves are insurance against deposit outows

Demand for Money

changes?
Excess reserves are insurance against deposit outows
The cost of holding these is the interest rate that could have
been earned minus the interest rate that is paid on these
reserves, (ier )

Demand for Money
Equilibrium in the Market for Reserves

Demand for Money
Demand in the Market for Reserves
When the policy rate is above the rate paid on excess

reserves,(ier ) as the policy rate decreases, the opportunity cost
of holding excess reserves falls and the quantity of reserves
demanded rises.

Demand for Money
Demand in the Market for Reserves
When the policy rate is above the rate paid on excess

reserves,(ier ) as the policy rate decreases, the opportunity cost
of holding excess reserves falls and the quantity of reserves
demanded rises.
Downward sloping demand curve that be comes at (innitely

elastic) at ier

Demand for Money
Supply in the Market for Reserves


Demand for Money

(1) the amount of reserves that are supplied by the Central

Bank's open market operations, called non-borrowed
reserves(Rn ) and

Demand for Money

(1) the amount of reserves that are supplied by the Central

Bank's open market operations, called non-borrowed
reserves(Rn ) and
(2) the amount of reserves borrowed from the Central Bank,

called discount loans (DL).

Demand for Money

Cost of borrowing from the Central Bank is the discount rate

Demand for Money

Borrowing from the Central Bank is a substitute for borrowing

from other banks (Rn ) and

Demand for Money


If iff < id then banks will not borrow from the Fed and
borrowed reserves are zero

Demand for Money


The supply curve will be vertical

Demand for Money


As iff rises above id banks will borrow more and more at id

and relend at iff

Demand for Money


As iff rises above id banks will borrow more and more at id

and relend at iff
The supply curve is horizontal (perfectly elastic) at id

Demand for Money
Response to an Open Market Operation

Demand for Money
How Changes in the Tools of Monetary Policy Aects the

Policy Rate
Eects of an open market operation depends on whether the

supply curve initially intersects the demand curve in its
downward sloped section versus its at section.

Demand for Money

Policy Rate

An open market purchase causes the policy rate to fall where

as an open market sale causes the policy to rise (when
intersection occurs at the downward sloped section).

Demand for Money

Policy Rate

An open market purchase causes the policy rate to fall where

as an open market sale causes the policy to rise (when
intersection occurs at the downward sloped section).
Open market operations have no eect on the policy rate when

intersection occurs at the at section of the demand curve.

Demand for Money
Responds to a change in the Discount Rate

Demand for Money

Policy Rate
If the intersection of supply and demand occurs on the vertical

section of the supply curve, a change in the discount rate will
have no eect on the policy rate.

Demand for Money

Policy Rate
If the intersection of supply and demand occurs on the vertical

section of the supply curve, a change in the discount rate will
have no eect on the policy rate.
If the intersection of supply and demand occurs on the

horizontal section of the supply curve, a change in the
discount rate shifts that portion of the supply curve and the
policy rate may either rise or fall depending on the change in
the discount rate

Demand for Money
Responds to a change in the Required Reserves

Demand for Money

Policy Rate
When the Central Bank raises reserve requirement, the

discount rate rises and when the Central Bank decreases
reserve requirement, the policy rate falls.

Overview of The Financial System and Some Basic Concepts Money Demand
Tools of Monetary Policy Theories of Money Demand
Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Demand for Money
Demand for Money
Recall the demand for money is made of transactions demand

and asset demand

Demand for Money
Demand for Money

and asset demand
The major determinants of demand for money are real interest

rate, level of income and expected ination rate

Demand for Money
Demand for Money

and asset demand

The quantity of money demanded falls when the interest rate

rises

Demand for Money
Demand for Money

and asset demand

The quantity of money demanded falls when the interest rate

rises
When interest rate rises, there is a higher incentive to allocate

more wealth to other interest-bearing assets and reduce the
holding of money balances

Demand for Money
Velocity of Money and the Equation of Exchange
M = the money supply
P = Price
Y = Aggregate output (income)

Demand for Money
P = Price
P * Y = Aggregate norminal income (nominal GDP)
V = Velocity of money (average number of times per year that

a cedi is spent)

Demand for Money
P = Price

a cedi is spent)
P∗Y
V =
M

Demand for Money
P = Price

a cedi is spent)
P∗Y
V =
M
Equation of exchange
M * V = P * Y

Demand for Money
Velocity fairly constant in short run

Demand for Money
Aggregate output at full-employment level

Demand for Money
Changes in money supply aect only the price level

Demand for Money
Movement in the price level results solely from change in the

quantity of money

Demand for Money

Demand for money: To interpret Fisher's quantity theory in
terms of the demand for money. . .

Demand for Money

Divide both sides by V

1
M =
V * PY

Demand for Money


1
M =
V * PY
1
k =
V

Demand for Money


1
M =
V * PY
1
k =
V
When the money market is in the equilibrium

M =
d M
Let Md = k * PY

Demand for Money


1
M =
V * PY
1
k =
V

M =
d M
Let Md = k * PY
Because k is constant, the level of transactions generated by a

xed level of PY determines the quantity of Md .

Demand for Money


1
M =
V * PY
1
k =
V

M =
d M
Let Md = k * PY
Because k is constant, the level of transactions generated by a

xed level of PY determines the quantity of Md .
The demand for money is not aected by interest rates.

Demand for Money
From the equation of exchange to the quantity theory of

money

Demand for Money

money
Fisher's view that velocity is fairly constant in the short run, so

that , transforms the equation of exchange into the quantity
theory of money, which states that nominal income (spending)
is determined solely by movements in the quantity of money M.

Demand for Money

money
Fisher's view that velocity is fairly constant in the short run, so

that , transforms the equation of exchange into the quantity
theory of money, which states that nominal income (spending)
is determined solely by movements in the quantity of money M.
P * Y = M * V̄

Demand for Money
Because the classical economists (including Fisher) thought

that wages and prices were completely exible, they believed
that the level of aggregate output Y produced in the economy
during normal times would remain at the full-employment level
.

Demand for Money

.
Dividing both sides by Ȳ , we can then write the price level as

follows:

Demand for Money

.
Dividing both sides by Ȳ , we can then write the price level as

follows:
M∗V̄
P =
Ȳ

Demand for Money

Demand for Money

Demand for Money

Demand for Money
Movement in the price level results solely from change in the

quantity of money

Demand for Money

Percentage Change in (x # y) = (Percentage Change in x) +
(Percentage change in y)

Demand for Money

Using this mathematical fact, we can rewrite the equation of

exchange as follows:
%4M + %4V = %4P + %4Y

Demand for Money


%4M + %4V = %4P + %4Y
Subtracting from both sides of the preceding equation, and

recognizing that the ination rate, is the growth rate of the
price level,
π = %4P = %4M + %4V - %4Y

Demand for Money


%4M + %4V = %4P + %4Y
Subtracting from both sides of the preceding equation, and

recognizing that the ination rate, is the growth rate of the
price level,
π = %4P = %4M + %4V - %4Y
Since we assume velocity is constant, its growth rate is zero,

so the quantity theory of money is also a theory of ination:
π = %4M - %4Y
Demand for Money
Relationship Between Ination and Money Growth

Demand for Money
Budget Decits and Ination
There are two ways the government can pay for spending:
raise revenue or borrow

Demand for Money
Raise revenue by levying taxes or go into debt by issuing

government bonds

Demand for Money
Raise revenue by levying taxes or go into debt by issuing

government bonds
The government can also create money and use it to pay for
the goods and services it buys

Demand for Money
The government budget constraint thus reveals two important

facts:

Demand for Money

facts:
If the government decit is nanced by an increase in bond

holdings by the public, there is no eect on the monetary base
and hence on the money supply.

Demand for Money

facts:
If the government decit is nanced by an increase in bond

holdings by the public, there is no eect on the monetary base
and hence on the money supply.
But, if the decit is not nanced by increased bond holdings by

the public, the monetary base and the money supply increase.

Demand for Money
Hyperination
Hyperinations are periods of extremely high ination of

more than 50% per month.

Demand for Money
Hyperination

Many economiesboth poor and developedhave

experienced hyperination over the last century, but the
United States has been spared such turmoil.

Demand for Money
Hyperination

Many economiesboth poor and developedhave

experienced hyperination over the last century, but the
United States has been spared such turmoil.
One of the most extreme examples of hyperination

throughout world history occurred recently in Zimbabwe in the
2000s.

Demand for Money
Outline
Introduction
Functions of Money
Measuring Money
Financial Market
Money Supply
4 Demand for Money
Money Demand
Demand for Money
Keynesian Theories of Money Demand
Keynes's liquidity preference theory

Demand for Money
Why do individuals hold money? Three motives:

Transactions motive
Precautionary motive
Speculative motive

Demand for Money
Why do individuals hold money? Three motives:

Transactions motive
Precautionary motive
Speculative motive
Distinguishes between real and nominal quantities of money

Demand for Money
Transaction Motive
Keynes initially accepted the quantity theory view that the

transactions component is proportional to income.

Demand for Money
Transaction Motive
Keynes initially accepted the quantity theory view that the

transactions component is proportional to income.
Later, he and other economists recognized that new methods

for payment, referred to as payment technology, could also
aect the demand for money

Demand for Money
Precautionary Motive
Keynes also recognized that people hold money as a cushion

against unexpected wants.

Demand for Money
Precautionary Motive
Keynes also recognized that people hold money as a cushion

against unexpected wants.
Keynes argued that the precautionary money balances people

want to hold would also be proportional to income.

Demand for Money
Speculative Motive
Keynes also believed people choose to hold money as a store

of wealth, which he called the speculative motive

Demand for Money
Putting the Three Motives Together
Md
P = f(i,Y) where the demand for real money balances is
negatively related to the interest rate i,
and positively related to real income

Demand for Money
Md
Rewritting
P 1
=
Md f (i,Y )

Demand for Money
Md
Rewritting
P 1
=
Md f (i,Y )
Multiply both sides by Y and replacing Md with M

PY Y
V =
M = f (i,Y )

Demand for Money
Velocity is not constant:

Demand for Money
The procyclical movement of interest rates should induce

procyclical movements in velocity.

Demand for Money
The procyclical movement of interest rates should induce

procyclical movements in velocity.
Velocity will change as expectations about future normal levels

of interest rates change

Demand for Money
Portfolio Theories of Money Demand
Theory of portfolio choice and Keynesian liquidity

preference

Demand for Money

preference
The theory of portfolio choice can justify the conclusion from

the Keynesian liquidity preference function that the demand
for real money balances is positively related to income and
negatively related to the nominal interest rate.

Demand for Money

preference
The theory of portfolio choice can justify the conclusion from

the Keynesian liquidity preference function that the demand
for real money balances is positively related to income and
negatively related to the nominal interest rate.
Other factors that aect the demand for money:

Wealth
Risk
Liquidity of other assets

Demand for Money
Factors that Determine the Demand for Money

Demand for Money
Empirical Evidence on the Demand for Money
Precautionary demand:
Similar to transactions demand

Demand for Money
As interest rates rise, the opportunity cost of holding

precautionary balances rises

Demand for Money
As interest rates rise, the opportunity cost of holding

precautionary balances rises
The precautionary demand for money is negatively related to

interest rates

Demand for Money
Interest Rate and Money Demand
We have established that if interest rates do not aect the

demand for money, velocity is more likely to be constantor
at least predictableso that the quantity theory view that
aggregate spending is determined by the quantity of money is
more likely to be true.

Demand for Money
Interest Rate and Money Demand
We have established that if interest rates do not aect the

demand for money, velocity is more likely to be constantor
at least predictableso that the quantity theory view that
aggregate spending is determined by the quantity of money is
more likely to be true.
However, the more sensitive the demand for money is to

interest rates, the more unpredictable velocity will be, and the
less clear the link between the money supply and aggregate
spending will be.

Demand for Money
Stability of Money Demand
If the money demand function is unstable and undergoes

substantial, unpredictable shifts as Keynes believed, then
velocity is unpredictable, and the quantity of money may not
be tightly linked to aggregate spending, as it is in the quantity
theory.

Demand for Money
If the money demand function is unstable and undergoes

substantial, unpredictable shifts as Keynes believed, then
velocity is unpredictable, and the quantity of money may not
be tightly linked to aggregate spending, as it is in the quantity
theory.
The stability of the money demand function is also crucial to

whether the Bank of Ghana (BOG) should target interest rates
or the money supply.

Demand for Money
If the money demand function is unstable and so the money

supply is not closely linked to aggregate spending, then the
level of interest rates the BOG sets will provide more
information about the stance of monetary policy than will the
money supply.

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Introduction: Overview of the Course

Overview of The Financial System and Some Basic Concepts

FINC 402: MONETARY THEORY

Dr. Edward Asiedu

University of Ghana Business School,Department of Finance

Oce Hours: Fridays 11:00am - 12:00 noon (UGBS Main

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Majority of us are going to be working with nancial

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Majority of us are going to be working with nancial

Financial intermediaries: institutions that borrow funds from

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Majority of us are going to be working with nancial

Financial intermediaries: institutions that borrow funds from

Banks: institutions that accept deposits and make loans.

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Majority of us are going to be working with nancial

Financial intermediaries: institutions that borrow funds from

Banks: institutions that accept deposits and make loans.

And therefore it is important to understand how nancial

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Also, importantly, to understand the role of money in the

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Also, importantly, to understand the role of money in the

Money, also referred to as the money supply, is dened as

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Also, importantly, to understand the role of money in the

Money, also referred to as the money supply, is dened as

Money plays a key role in generating business Cycles

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Also, importantly, to understand the role of money in the

Money, also referred to as the money supply, is dened as

Money plays a key role in generating business Cycles

Business Cycles are upward and downward movement of

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Business cycles aect all of us in immediate and important

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Business cycles aect all of us in immediate and important

Thus, recession (unemployment) and economic booms aect

Dr. Edward Asiedu Monetary Theory

Why should Accountants and Financial Analysts be

Business cycles aect all of us in immediate and important

Thus, recession (unemployment) and economic booms aect

Changes in the money supply impacts changes in aggregate

Dr. Edward Asiedu Monetary Theory

Aims of the course

The three main aims of the course are:

Dr. Edward Asiedu Monetary Theory

Aims of the course

The three main aims of the course are:

To enhance students understanding of the monetary and

Dr. Edward Asiedu Monetary Theory

Aims of the course

Oce Hours: Fridays 11:00am - 12:00 noon (UGBS Main

Majority of us are going to be working with nancial

Majority of us are going to be working with nancial

Majority of us are going to be working with nancial

Majority of us are going to be working with nancial

And therefore it is important to understand how nancial

Money, also referred to as the money supply, is dened as

Money, also referred to as the money supply, is dened as

Money, also referred to as the money supply, is dened as

Business cycles aect all of us in immediate and important

Business cycles aect all of us in immediate and important

Thus, recession (unemployment) and economic booms aect

Business cycles aect all of us in immediate and important

Thus, recession (unemployment) and economic booms aect

Denition and Nature, Functions and Value of Money

Denition and Nature, Functions and Value of Money

Denition and Nature, Functions and Value of Money

Denition and Nature, Functions and Value of Money

Denition and Nature, Functions and Value of Money

Denition and Nature, Functions and Value of Money