Additional Money ConceptsAdditional Money ConceptsMoney and InflationElias YannopoulosNovember 5, 2012Elias Yannopoulos Money and InflationAdditional Money ConceptsAnnouncementsAfter today I will have finished chapters 13-14 and I will beginnext time with chapter 16 and come back to chapter 15 afterthatEven with all of that I am rapidly running out of content andinstead of going over more material I am canceling class onFriday Nov, 9th and Friday Nov 16thAlso Remember that there is already no class on November19th (The Monday before Thanksgiving)Elias Yannopoulos Money and InflationAdditional Money ConceptsMoney MultiplierRemember I previously talked about the simple moneymultiplier =1rrThis was the money multiplier under two assumptions:Banks hold no excess reservesPeople hold no currencyWhat happens to the money multiplier when we relax theseassumptions?If we relax the first assumption that banks hold no excessreserves then what we need to use is the reserve ratioreserve ratio (r) - the ratio of total reserves (required andexcess) to depositsThe math works the same as with the simple money multiplierand we get1rElias Yannopoulos Money and InflationAdditional Money ConceptsMoney Multiplier Cont.When we relax the second assumption and allow people tohold currency things get more complicatedThe tricky part of the math is understanding (c) - this is theratio of currency to deposits for peopleThis is not the ratio of currency you hold to your total moneyholdingsThe reason for this is so that we have a nice formula at theend for the money multiplierBut if we want to run through the logic and math I did for thesimple money multiplier we are gonna need the ratio ofdeposits to money holdingsIf c is as defined above thenc1+cif the ratio of currency tototal money holdingsTo find deposits to money holdings we simply subtract fromone: 1 −c1+c=11+cAfter going through the math we get a multiplier1+cr +cElias Yannopoulos Money and InflationAdditional Money ConceptsMoney MarketWhy do people want to hold money? As opposed to otherfinancial assets like bonds that earn interestThere are three main motives for holding moneyTransactions motive - you need to hold money so you canbuy thingsPrecautionary motive - holding money for unexpectedexpenses Ex: fix your carSpeculative motive - holding cash to avoid holding financialassets whose prices are fallingThese make up the reasons why people demand money, andjust like other assets money has a price but it function a bitdifferentlyThinking about the speculative motive for holding money thelower the interest rates of assets you would hold instead ofmoney the more money you holdElias Yannopoulos Money and InflationAdditional Money ConceptsMoney Market Cont.The Money Market is the market for short term borrowing,lending, buying and selling of securities with maturities of oneyear or lessThere are many interest rates in the economy, you can thinkof the loanable funds interest rate as the composite rate of allthere different financial assetsThe Money Market interest rate is the rate on these shortterm lending, and this is the interest rate that affects thedemand for people holding moneyThe lower the interest rate of the money market the lesscostly it is to hold money (the alternative is lending in themoney market)Thus the demand for money slopes downward in the moneymarket interest rateWe assume the supply of money is fixed with respect to themoney market interest rateElias Yannopoulos Money and InflationAdditional Money ConceptsMonetary PolicyRemember that the Fed has a target for the Federal Fundsrate but do not control it directlyHow can they influence the Federal Funds rate?Federal Funds are part of the money market, banks can go toeach other or to the general money market to make or receiveshort term loansHow does the Fed use monetary policy to affect the moneymarket?First, lets look at an expansionary monetary policy -increase in the money supply (OM purchase) Ex: graphSecond, lets look at a contractionary monetary policy -decrease in the money supply (OM Sell) Ex: graphElias Yannopoulos Money and InflationAdditional Money ConceptsTreasury SecuritiesI have been using a lot of different language for Treasurysecurities and I want to clean up the detailsTreasury Bills (T-Bills) - Maturity of 1 yr or less, do not payinterest prior to maturityTreasury notes (T-Notes) - Maturity of 2 - 10 yrs, have acoupon payment (interest payment) every six monthsTreasury bonds (T-Bonds) - Longest maturity treasurysecurities 20 - 30 yrs, usually 30 yrs, they have a 6 monthcoupon payment like T-NotesElias Yannopoulos Money and
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