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1、Chapter 22The Demand for Money 2005 Pearson Education Canada Inc.Quantity Theory of MoneyVelocityP YV=MEquation of Exchange M V=P YQuantity Theory of Money1.Irving Fishers view:V is fairly constant2.Equation of exchange no longer identity3.Nominal income,PY,determined by M4.Classicals assume Y fairl
2、y constant5.P determined by MQuantity Theory of Money Demand1 M=PY VMd=k PYImplication:interest rates not important to Md 2005 Pearson Education Canada Inc.2Change in Velocity from Year to Year:191520023 2005 Pearson Education Canada Inc.Cambridge ApproachIs velocity constant?1.Classicals thought V
3、constant because didnt have good data2.After Great Depression,economists realized velocity far from constant4 2005 Pearson Education Canada Inc.Keyness Liquidity Preference Theory3 Motives1.Transactions motiverelated to Y2.Precautionary motiverelated to Y3.Speculative motiveA.related to W and YB.neg
4、atively related to iLiquidity PreferenceMd=f(i,Y)P+5 2005 Pearson Education Canada Inc.Keyness Liquidity Preference TheoryImplication:Velocity not constantP1 =Md f(i,Y)Multiply both sides by Y and substitute in M=MdPYYV=Mf(i,Y)1.i ,f(i,Y),V 2.Change in expectations of future i,change f(i,Y)and V cha
5、nges6 2005 Pearson Education Canada Inc.Baumol-Tobin Model of Transactions DemandAssumptions1.Income of$1000 each month2.2 assets:money and bondsIf keep all income in cash1.Yearly income=$12,0002.Average money balances=$1000/23.Velocity=$12,000/$500=24Keep only 1/2 payment in cash1.Yearly income=$12
6、,0002.Average money balances=$500/2=$2503.Velocity=$12,000/$250=48Trade-off of keeping less cash1.Income gain=i$500/22.Increased transactions costsConclusion:Higher is i and income gain from holding bonds,less likely to hold cash:Therefore i,Md 7 2005 Pearson Education Canada Inc.Cash Balance in Bau
7、mol-Tobin Model8 2005 Pearson Education Canada Inc.Precautionary and Speculative MdPrecautionary DemandSimilar tradeoff to Baumol-Tobin framework1.Benefits of precautionary balances2.Opportunity cost of interest foregoneConclusion:i,opportunity cost,hold less precautionary balances,Md Speculative De
8、mandProblems with Keyness framework:Hold all bonds or all money:no diversificationTobin Model:1.People want high Re,but low risk2.As i,hold more bonds and less M,but still diversify and hold MProblem with Tobin model:No speculative demand because T-bills have no risk(like money)but have higher retur
9、n 2005 Pearson Education Canada Inc.9Friedmans Modern Quantity TheoryImplication of 3:MdY=f(YP)V=Pf(YP)Since relationship of Y and YP predictable,4 implies V is predictable:Get Q-theory view that change in M leads to predictable changes in nominal income,PYTheory of asset demand:Md function of wealt
10、h(YP)and relative Re of other assetsMd=f(YP,rb rm,re rm,e rm)P+Differences from Keynesian Theories1.Other assets besides money and bonds:equities and real goods2.Real goods as alternative asset to money implies M has direct effects on spending3.rm not constant:rb,rm,rb rm unchanged,so Md unchanged:i
11、.e.,interest rates have little effect on Md4.Md is a stable function 2005 Pearson Education Canada Inc.10Empirical Evidence on Money DemandInterest Sensitivity of Money DemandIs sensitive,but no liquidity trapStability of Money Demand1.M1 demand stable till 1973,unstable after2.Most likely source of instability is financial innovation3.Cast doubts on money targets11 2005 Pearson Education Canada Inc.