Money

Pavel Molchanov

HSE University

11 April 2023

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Content of the lecture

Literature:
− Andrew B. Abel, Ben Bernanke and Dean Croushore -
Macroeconomics, Global Edition 10-Pearson (2020), chapter 7.
▶ Telegram group: https://t.me/+ai5UoVkj3FU5NmYy
▶ or search for: t.me/macro_hse_Molchanov_2023

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Functions of Money

▶ Medium of Exchange
(in contrast to barter)
money permits people to trade at less cost in time and effort
▶ Unit of Account
(in contrast to pricing food in dollars, real estate in gold, and etc.)
money is the basic unit for measuring economic value
If local currency is not stable, it is reasonable to price goods in foreign
currency.
▶ Sore of Value
stocks, bonds, or real estate also perform this function

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Frame Title

Fiat money vs Commodity money.

▶ fiat money have no intrinsic value
▶ commodity money are partially useful (like gold, cigarettes)
Evolution of money:
1. Gold coins: useful, but need to verify the purity
2. Government issued coins: no need to verify the purity
3. Paper notes that can be exchanged back to gold (backed by gold):
no need to carry around bags of gold
4. Paper notes that can not be exchanged for gold directly,
continue to be accepted by everyone and facilitate transactions

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Measuring Money

Money is defined as those assets that are widely used and accepted in
payment.
The distinction between monetary assets and nonmonetary assets isn’t
very clear: cryptocurrency is both an investment asset and money.
There are different official measures of the money stock.
Monetary aggregates:
▶ M0 — (also denoted as C) currency
▶ M1 — currency + checks + ...
▶ M2
▶ M3 — institutional money + long-term saving deposits

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The M1 Monetary Aggregate

Consists primarily of currency and balances held in checking accounts.

▶ currency
▶ checks
▶ transaction accounts — allowing transfers and usage of ATM
All these components are actively used and widely accepted for making
payments.

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The M2 Monetary Aggregate

▶ M1
▶ savings deposits
▶ small-denomination (under $100,000) time deposits
- are interest-bearing deposits with a fixed term (early withdrawal
usually involves a penalty)
▶ noninstitutional holdings of money market mutual funds (MMMFs)
- invest in short-term securities - allow holders to write a limited
number of checks
▶ money market deposit accounts (MMDAs)
All of these accounts have limits on the number of checks or other
transfers that can be written each month.

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The Demand for Money

The demand for money is the quantity of monetary assets, such as cash
and checking accounts, that people choose to hold in their portfolios.
Money:
▶ high liquidity assets
▶ low return and low risk
Determinants of money demand:
▶ the price level
▶ real income
▶ the interest rate

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Determinants of Money Demand
The price level:
- If prices grow 10 times, you need 10 times as much money to make the
same transactions. - All else equal, money demanded is proportional to the
increase in the price index.
Real income:
- The more transactions that individuals or businesses conduct, the more
liquidity they need and the greater is their demand for money.
- higher real income = more goods purchased → more transactions →
higher demand for money
- money demanded need not be proportional to real income
The interest rate:
- an increase in the expected return on alternative assets causes holders of
wealth to switch from money to higher-return alternatives, thus lowering
the demand for money
Additionally: Riskiness of alternative assets or of money
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The Money Demand Function

M d = P × L (Y , i) ,
where
▶ M d — the aggregate demand for money, in nominal terms;
▶ P — the price level;
▶ Y — real income or output;
▶ i — the nominal interest rate earned by alternative, nonmonetary
assets;
▶ L — a function relating money demand to real income and the
nominal interest rate.

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The Money Demand Function

The real interest rate is different from the nominal interest rate:
(Fisher equation)
i= r
|{z} + |{z}π
real interest rate inflation rate

then
M d = P × L (Y , r + π) ,

⋄ Money demand depends on the current price level and on the

expected rise in the price level;
▶ ∂M d ∂M d
∂r = ∂π <0

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Empirics of Money Demand

Empirically estimated elasticities of money demand:

▶ EM d (P) ≈ 1
▶ EM d (Y ) ≈ 2/3
▶ EM d (i) ≈ [−0.2, −0.1]

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Velocity and the Quantity Theory of Money

Velocity measures how often the money stock “turns over” each period —
same dollar can be used multiple times per a period of time.

nominal GDP PY
V = =
nominal money stock M

Assume that there are M = 10$ in the economy, and the price of a salad
equals P = 1$. If each dollar is used twice per year (V = 2) then a
student will buy
Y = VM = 2 × 10 = 20 salads
If V = 1/k and is assumed to be constant, then

M
= kY
P

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the Quantity Theory of Money

MV = PY
The quantity theory of money implies that the price level is proportional to
the money supply.
Take total derivative and divide by the initial equation:

∆M ∆V ∆P ∆Y
+ = +
M V P Y

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Inflation and Money Growth

Central Bank can change money supply in the economy by buying or

selling government bonds.
▶ If it wants to increase money supply, it can print money and buy out
government bonds.
▶ If it wants to decrease money supply, it can issue and sell government
bonds.
The process: more money → more income → higher demand for goods →
prices go up → new equilibrium

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Seigniorage

Seigniorage — revenue raised by the government through printing money.

seigneur — French word seigneur for "feudal lord"
government gains revenue and can finance public goods
public loses because of higher inflation and lower real income (inflation
tax).

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M1 and M2 velocities graph

Money velocity is not constant

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Money and Inflation link

Money velocity is not constant

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