Demand for Money transaction, cautionary, speculative; GDP up DM up IR price of money IR

D if risk is high demand tends to be lo monetarists! control of money supply"ma#or tool in controlling the economy $eynesians! fiscal policy Monetarists physical assets"substitutes for financial assets, IR less elastic, transactions motive is main motive Bonds %loan& fi'ed interest rate %nominal value&; can be traded to calculate price! IR"(,)* +IR")* ,-".//0 )1'"(/2)1.// '"3/0 inverse relationship bet een bond prices and interest rates Interest Rates IR
e'cess supply e5uilibrium

Money 4upply

e'cess demand

6P7

8 e'cess demand! people sell non9monetary assets; banks lose funds IR up; people sell bonds and government securities e5uilibrium e'cess supply! people ant to save so IR goes do n e5uilibrium ,+! 6P7 and M4 can also shift; nominal IR different real IR Banks central banks! supervise other banks : operate gov; m;p; commercial banks! private companies %profit&, must keep a reserve dictated by the central bank The Quantity Theory of Money <isher=s e5uation! M ' - " P ' >%"?& @e assume that - : > are constant M " a ' P : a " >1 delta M brings delta P %monetarists& 1

Monetarists believe that! - : > are constant in the short run; money is mainly held for transactions; D for M stable function of income; M should increase 1 increase in real income %other ise inflation&, delay bet een change in IR and change in MD $eynesians believe that! D for M is unstable; an increase in M can be ofset by a decrease in -; 7+As might accommodate a higher M because the conse5uences are bad %unemployment, recession&, link bet een delta M4 and delta BD is indirect, the trigger for a change in money demand is not a change in interest rate Monetary Policy goals/objectives! full employment, favourable balance of payments, price stability : economic gro th olicy instruments! IR! set by C7+ : implemented by the 7+ of the CuroDone %C47+&; Ether banks follo this policy for their activities; >hese banks can control li5uidity in the market e';! buy bonds M up : vice versa open market operations %EME&! bond buying and selling& monetary base control! ad#usting the reserve assets ratio rules and regulations! e' 7+ can ad#ust siDe of deposits from commercial banks; 5uantitative easing! used hen conventional monetary instruments are no longer possible %e';! Dero lo er bound&; 0 in#ected into the economy%buying bonds& bond prices up : yield do n effective IR falls pple are discouraged to save : spend more limitations of monetary policy! time lags %(m to 2y&; reliable data %old, errors&; hat is MF; disintermediation! banks bringing lenders : borro ers together; GoodhartAs la ! causal relationship bet een 2 variables, e use one to control the other, eventually the relationship ill break do n; monetary base control! very hard to control the ./*; demand for money! e assume that 6P7 is stable but it also depends on elasticity; policy constraints! M:IR e canAt ad#ust both at the same, M IR:debt to attract loans %bonds& IR up but then M do n and deflates economy deficit increases, M IR : e'change rates a high IR makes currency more attractive value increases e'ports e'pensive and imports cheaper Trade !ycles

boom recession trough

recovery

boom! high BD; profits encouraging; firms produce at or near full capacity; incentive to invest; lo unemployment; high income recession % hen real ,I declines for 2 consecutive 5uarters&! supply affected by shortages %e'; 6abor&, bottlenecks etc;, firms offer higher ages to attract key orkers costs increase, profits fall, IR up as firms demand loan, prices tend to rise %inflation& chokes demand inflation falls us ; output falls, unemployment increases, do n ards multiplier recovery! usually starts 1 increase in investment %lo IRF&; firmAs capacity has fallen so much that they need to invest; investment up up ards multiplier %output up income up BD up unemployment do n& ,+! multiplier9accelerator model of the trade cycle trade cycle indicators" leading indicators %give indication as to hat is going to happen&! level of investment, #ob vacancies, e'pectations lagging indicators %follo the trade cycle&! 2

unemployment, e'ports1imports, level of consumption and ages %F sticky on the ay do nG& coincident indicators %respond 5uickly to the cycle&! IR %if part of govAt policy&, level of consumption, supply : demand shortages #iscal Policy definition! ta' spending limitations of fiscal olicy! conflicting policies e'! stop:go govAt reduces ta' : increases e'penditure in recession inflation so govAt increases ta' : reduces e'penditure time lags (m92y, siDe of the multiplierF 6arge capital pro#ects take time to ork through the economy but ta' : civil servant salaries have a 5uick effect data historical %(m or more& and pro#ections not al ays reliable, errors %residual error, balancing item& inade5uate kno ledge e assume our kno ledge of ho the economy orks is good $nem loyment definition! unemployed! people of orking age ready, illing and able to ork costs of unem loyment! personal! loss of 0, stigma, loss of esteem, long term %H.y& higher incidence of ph : m illness, stress, depression, marital breakdo n, DR up, the longer the harder to find a #ob local communities! area tends to run do n, vandalism, crime etc; ta'payer! less ta' revenue : elfare up economy as a hole! opportunity cost, loss of output, social cost up ty es of unem loyment! market in dise5uilibrium and market in e5uilibrium dise5uilibrium! .9 cyclical1demand deficient1$eynesian 29classical1real age unemployment elfare too high or minimum age too high; pressure from trade unions; ages are IstickyJ do n ards e5uilibrium! frictional unemployment; seasonal unemployment; structural % orkerAs skill doesnAt match #obs offered& unemployment %4HD&! regional, sectoral, technological keynesian aggregate supply the Philli s curve $B47 adapted for P7 curve

trade9off bet een inflation and unemployment

fe"full employment level of output

fle'ibility

.KL/As9relationship broke %stagflation& the end of money illusion% orkers thinking ithout taking inflation under account& e% ectations augmented Philli s curve or long run Philli s curve or natural rate of unem loyment curve or &'IR$ (non)accelerating inflation rate of unem loyment*

Inflation Rate
NAIRU or Long-Run Phillips Curve

New Short-Run Phillips Curve Initial Short-Run Phillips Curve

Unemployment Rate

,BIRM " rate of unemployment that holds inflation steady ,B@RM %n; a; age r; of inflation& " level of unemployment that holds ages steady& su ly side olicies! cyclical unemployment dealt ith by using macroeconomic policies %mostly fiscal&; Ether types of unemployment dealt ith by using supply9side policies %allo the market to operate more freely& Inflation + deflation inflation general increase in the price level; deflation general decrease in the price level; disinflation rate of inflation falls cree ing inflation! long term, gradual increase in prices hy erinflation! rapid, large increase of prices %H.//*& ty es/causes of inflation! monetary hen M supplyHec; gro th demand9pull inflation BDH4 at current prices%normally associated to full employment& reasons! country has e'port drive ,I up domestic D up prices up; country increases investment to improve ec; gro th less consumer goods e'cess BD inflation; cost9push inflation! costs of production Ipush upJ prices oil prices, ages rising faster than productivity, indirect ta' age9price spiral %vicious cycle&; high income divisions stagflation possible; ages are IstickyJ do n ards costs of inflation! shoe9leather costs : menu costs slo , steady rate of inflation good anticipated inflation acceptable unanticipated inflation dangerous unemployment1lack of gro th! increased costs %labour, ra materials& can lead to unemployment and slo gro th; high nominal IR makes borro ing unattractive; can make e'ports less : imports more attractive business! creates uncertainty %businesses have to IcoverJ themselves against future cost increases& pushes IR up as a counter inflationnary policy but maybe by lenders to make sure they get a return debtors gain and creditors lose %in general& cash! itAs less popular, gold : art become popular fi'ed incomes! they lose %pensions, elfare payments&