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ABA203 Money and Banking Lecture 3: Demand For Money: Arieswong@chuhai - Edu.hk

This document discusses theories of demand for money, including the quantity theory of money, Keynes' liquidity preference theory, and portfolio theories. It explains that demand for money is determined by transactions needs, precautionary motives, speculative motives, interest rates, income, wealth, risk, and liquidity. Keynes argued that demand depends on interest rates in addition to income. Later theories emphasized money as an asset within a portfolio, affected by various financial factors. Empirical evidence supports demand for money being influenced by multiple economic and financial variables rather than just income and money supply.

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8 views

ABA203 Money and Banking Lecture 3: Demand For Money: Arieswong@chuhai - Edu.hk

This document discusses theories of demand for money, including the quantity theory of money, Keynes' liquidity preference theory, and portfolio theories. It explains that demand for money is determined by transactions needs, precautionary motives, speculative motives, interest rates, income, wealth, risk, and liquidity. Keynes argued that demand depends on interest rates in addition to income. Later theories emphasized money as an asset within a portfolio, affected by various financial factors. Empirical evidence supports demand for money being influenced by multiple economic and financial variables rather than just income and money supply.

Uploaded by

Charles MK Chan
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
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ABA203 Money and Banking

Lecture 3 Demand for Money

ABA203 Money and Banking

Lecture 3 Demand for Money

ABA203 Money and Banking

Lecture 3 Demand for Money

Quantity Theory of Money

Quantity Theory of Money (contd)


Demand for money: To interpret Fishers quantity theory in terms of the demand for money Divide both sides by V 1 1 k= M = PY V V

ABA203 Money and Banking


Lecture 3: Demand for Money
Senior Lecturer Mr. Aries Wong M.Phil., M.Sc., CPA, CFA [email protected] http://arieswong.weebly.com/

Velocity of Money and The Equation of Exchange


M = the money supply P = price level Y = aggregate output (income) P Y = aggregate nominal income (nominal GDP) V = velocity of money (average number of times per year that a dollar is spent) PY M Equation of Exchange M V = P Y V=

M d = k PY
When k is constant, the level of transactions generated by a fixed level of PY determines the quantity of Md. The demand for money is not affected by interest rates

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Keynesian Theories of Money Demand


Keyness Liquidity Preference Theory

Transactions & Precautionary Motives


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 affect the demand for money (think abut the impact on V).

Speculative Motive
Keynes also believed people choose to hold money as a store of wealth, which he called the speculative motive. Money earns no interest and therefore its the opportunity cost is the nominal interest rate on bonds.

Why do individuals hold money? Three Motives


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

Keynes also recognized that people hold money as a cushion against unexpected wants and argued such precautionary money balances people want to hold would also be proportional to income.

When interest rate raise above the normal level (or the long-term trend), it is expected to fall and thus the bond price is expected to raise and vice versa.
Hold bond when interest rate is high and hold money when interest rate is low.

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Chu Hai College of Higher Education ABA203 Money and Banking

Aries Wong Lecture 3 Demand for Money

Putting the Three Motives Together


Md = f ( i, Y ) where the demand for real money balances is P negatively related to the interest rate i, and positively related to real income Y Rewriting P 1 = f ( i, Y ) Md Multiply both sides by Y and replacing M d with M PY Y V= = M f ( i, Y )
Implication: Velocity is not constant and is negatively related to interest rate.
Chu Hai College of Higher Education Aries Wong

More on Interest Rate and Money

Portfolio Theories of Money Demand


The approach taken by Milton Friedman emphasize the role of money as a store of vale and a part of peoples overall portfolio of assets. These theories thus introduce more factors that affect the demand for an assets including Wealth Risk relative to other assets

Demand: Baumol - Tobin model


William Baumol and James Tobin have elaborated on Keynes approach and demonstrated additional link between interest rate and transactions/precautionary demand for money. Holding money forgoes the opportunity to earn interest on interest-bearing assets, e.g. bond. The transaction component of the demand for money is negatively related to the level of interest rate.

Liquidity relative to other assets

Chu Hai College of Higher Education

Aries Wong

Chu Hai College of Higher Education

Aries Wong

ABA203 Money and Banking

Lecture 3 Demand for Money

ABA203 Money and Banking

Lecture 3 Demand for Money

Empirical Evidence on the Demand for Money


Summary Table 1 Factors That Determine the Demand for Money

Demand for Money: A Short Summary


QTM asserts a constant velocity and implies a straight forward relationship between nominal output and demand for money. Considering the function of money as a store of value (lets simply refer to asset), Keynes argued that demand for money should be determined by interest rate as well. Friedman and other further emphasize the role of money as an asset and including wealth, relative risk, relative liquidity as factors affecting demand for money.

When demand for money is determined by more and more factors, the link between money and nominal output (PY) is less clear.

Chu Hai College of Higher Education

Aries Wong

Chu Hai College of Higher Education

Aries Wong

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