Macroeconomics

Money concepts: M0, M1, M2, M3

Demand function for money
Bonds
Why is this
money????
Why is this
money????
MC of production ???????
 From the old days….
To make paper money generally accepted
 From the old days….
To make paper money generally accepted
 What is money?

What must be fulfilled for something to be called money???

 Medium of exchange
 Unit of account
 Store of value

Furthermore:

 Generally accepted
 Liquid
Money is:

• Unit of account

• Medium of exchange

• Store of value
Morten Hansen
 Liquid

 Generally accepted
Thus, in the Eurozone:
 What is money?

What must be fulfilled for something to be called money???

 Medium of exchange
 Unit of account But, some problems:
 Store of value
o Online trade
o Small traders/some cafes
Furthermore:
o Inflation

 Generally accepted
 Liquid
 Monetary aggregates

M0 Liabilities of the central bank (cash in circulation +

commercial bank deposits in CB)

M1 Narrow money; most liquid

Cash in circulation + overnight deposits

M2 Broad money; less liquid

M1 + savings deposits

M3 M2 plus various debt securities, money market funds…

Smart graph (I think…) for analysis

Government

Central Commercial Society

bank banks
M0 M1, M2, M3
Nominal GDP of
the Eurozone in
2023

~ 14.3 trillion EUR

For comparison: Eurozone GDP 2022 ~ 13,672 bill. EUR
M2 = 15,053 bill. EUR
M2, broad money

M1 + time deposits

M1, narrow money

Currency in circulation

Overnight deposits
(‘plastic money’)
M2, broad money
Less
M1 + time deposits liquid

M1, narrow money Very

Currency in circulation liqui
d
Overnight deposits
(‘plastic money’)
 Growth rate of Eurozone M2, y-o-y
1999-I – 2023-XI
14

12

10

0
1999Jan 2000Dec 2002Nov 2004Oct 2006Sep 2008Aug 2010Jul 2012Jun 2014May 2016Apr 2018Mar 2020Feb 2022Jan

-2

-4
 Growth rate of Eurozone M2, y-o-y
1999-I – 2023-XI
14
February 2021
November 2007
12

10

4
January 2020
2

0 April 2010
1999Jan 2000Dec 2002Nov 2004Oct 2006Sep 2008Aug 2010Jul 2012Jun 2014May 2016Apr 2018Mar 2020Feb 2022Jan

-2

-4
 Money demand

Motives for ‘holding’ (= demanding money)

 Transactions motive

 Speculative motive

 Precautionary motive
 Money demand

Motives for ‘holding’ (= demanding money)

 Transactions motive
~ money as a medium of exchange
 Speculative motive
~ money as a store of value
 Precautionary motive
~ money as a medium of exchange
 Money demand

Motives for ‘holding’ (= demanding money)

 Transactions motive
~ money as a medium of exchange (related to C)
 Speculative motive
~ money as a store of value (related to S)
 Precautionary motive
~ money as a medium of exchange (related to C)
 Transactions demand

 During the month we receive salary once

 But we make frequent purchases

Receiving and spending money are not synchronized

– between receiving and spending, we hold (= demand) money
 Example

Back from my days as a student:

At the end of the month:

 Nothing in my pockets…..
 Nothing in my bank account…..
 Money I hold

Time
01.02 28.02
 Money I hold

280

Time
01.02 28.02
 Money I hold
If spent in equal
amounts per day

280

Time
01.02 28.02
 Money I hold
If spent in equal
amounts per day

280

Time
01.02 28.02
 Money I hold
Average amount of money held per day:

(280+270+260+ …..)/28 =

280

Time
01.02 28.02
 Money I hold
Average amount of money held per day:

(280+270+260+ …..)/28 = 140

280

Time
01.02 28.02
 Wait a minute…

Money demand is a too simple name, according to Lord Keynes

 Wait a minute…

Money demand is a too simple name, according to Lord Keynes

Liquidity
preference

(Real) money demand: L

 Money I hold

280 L = 140

Time
01.02 28.02
 Money I hold

280 L = 140

Time
01.02 28.02
 Money I hold

280 L = 140

L << 140

Time
01.02 28.02
 Money I hold
When I stopped
being a student
and got a job…

280

Time
01.02 28.02
 Money I hold
When I stopped
being a student
and got a job

280
Bigger money demand
due to higher income

Time
01.02 28.02
 Developing the money demand function

L=f(Y,
+
 The speculative demand for money

Based on the store of value motive for holding money

Thus, based on savings

How can we hold our savings:
No risk (“5 EUR = 5 EUR”)
Risky: Its prices may go up – or down…….
Tesla share price,
USD
23 May 2022
 In our macro perspective

No risk

Risky

Money ><
bonds
 In our macro perspective

No risk – and little/no return

Risky – but perhaps with some return

Money ><
bonds
 Savings

S=M+B

M B
 Photo from the
Latvian
Ministry of Finance
Types of bonds (US perspective)

• Government
• Corporate
• Mortgage
 Bonds

Government bond: Example:

A loan agreement: Face value: 1000 EUR

Coupon: 1%
The government is obliged to Time to maturity: 1
repay: year

a certain amount (face value) at

• Bond price
a certain date (time to maturity)
• Yield/interest rate
…. paying a
certain interest rate (coupon)
15 November 2023
11 January 2023
https://eng.lsm.lv/article/economy/economy/latvian-t-bond-auction-raises-24-million-euros.a335909/
 LETA news 13 February 2019

Time to maturity

Very long bond

Yield/interest rate

Coupon
Total face value of all the bonds
Size of the US bond market

World bond market:

Some 82 trillion $
 Bonds

Government bond: Example:

A loan agreement: Face value: 1000 EUR

Coupon: 1%
The government is obliged to Time to maturity: 1
repay: year

a certain amount (face value) at

• Bond price
a certain date (time to maturity)
• Yield/interest rate
…. paying a
certain interest rate (coupon)
 Timeline

1000 EUR
Buy the bond +
10 EUR

Time
03.02.2024 03.02.2025
What if the bond was for sale for 950 EUR???
 Timeline

Receive

1000 EUR
Pay 950 EUR +
10 EUR

Time
03.02.2024 03.02.2025
 What if the bond was for sale for 950 EUR???

Gain per 1 EUR of this financial investment/saving:

 What if the bond was for sale for 950 EUR???

Gain per 1 EUR of this financial investment/saving:

i: Yield or interest rate

 What if the bond was for sale for 900 EUR???

Gain per 1 EUR of this financial investment/saving:

i: Yield or interest rate

 Important relationship

Bond prices and interest rates are inversely

related:
 Example from USA
US 10-year bond (T-bill) interest rate
 Example from USA
US 10-year bond (T-bill) interest rate

Interest rate up, so

bond price down…
pbond

Dbond

Amount
of bonds
pbond
Sbond

Dbond

Amount
Ex: 10,000 x 1000 EUR of bonds
pbond
Sbond

Dbond

Amount
Ex: 10,000 x 1000 EUR of bonds
 Bonds

Government bond: Example:

A loan agreement: Face value: 1000 EUR

Coupon: 0%
The government is obliged to Time to maturity: 1
repay: year

a certain amount (face value) at

• Bond price
a certain date (time to maturity)
• Yield/interest rate
…. paying a
certain interest rate (coupon)
 Ex: Let’s say the bond was
pbond bought for 950 EUR

950
EUR

Time
03.02.2024 03.02.2025
 pbond Ex: Let’s say the bond was
bought for 950 EUR

1000 EUR

950
EUR

Time
03.02.2024 03.02.2025
 pbond Ex: Let’s say the bond was
bought for 950 EUR

1000 EUR

950
EUR

Time
03.02.2024 03.02.2025
 What will be the market price of the bond

… on 2 February 2025 ??????

- one day before it matures…….

 pbond Ex: Let’s say the bond was
bought for 950 EUR

1000 EUR

950
EUR

Time
03.02.2024 03.02.2025
 Result

Short bonds should be less volatile

i.e. less risky

 pbond

1000 EUR

Time to
maturity
1 year 5 years 30 years
 Result

Short bonds should be less volatile

i.e. less risky

We should thus expect shorter bonds to have lower interest

rates (typically..), reflecting:

 Less volatility
 Higher liquidity
i

Term structure of
interest rates

Time to
maturity
 Developing the money demand function

L=f(Y, i
+ –
Argument:
The higher is the bond interest rate – all other things
held constant – the more attractive it is to hold bonds
and thus NOT hold money
 Developing the money demand function

L=f(Y, i )
+ –
This is the money demand function we shall use for
analysis – but we can add a few more arguments for a
better understanding
 Developing the money demand function

L = f ( Y , i , i(exp)
+ – +
If we expect bond interest rates to rise tomorrow, we
expect bond prices to fall tomorrow – alas, sell bonds
today and hold money instead, L up
 Developing the money demand function

L = f ( Y , i , i(exp), π
+ – + –
If inflation is higher, money loses its store of value
property faster – hold less money; hold other assets
instead (inflation up, money demand down)
 Developing the money demand function

L = f ( Y , i , i(exp), π
+ – + –
If inflation is higher, money loses its store of value
property faster – hold less money; hold other assets
instead (inflation up, money demand down)
Here, the example of Belarus is very good
e(BYN/USD) – Belarusian rubles per USD

A USD has become some

150% more expensive in
1 USD costsofmore
terms BYN than 3
BYN, up from about 1 BYN
5 years ago
 e(BYN/USD)

e(BYN/USD)  from 1.00 BYN per USD to about 3.30 BYN/USD

a 230% increase

Or, as e(USD/BYN)
1.00 USD per BYR to 0.30 USD per BYR
 e(BYR/USD)

e(BYN/USD)  from 1.00 BYN per USD to about 2.50 BYN/USD

230% increase

Or, as e(USD/BYN)
1.00 USD per BYN to 0.30 USD per BYN

 A 70% decline in the value of BYN

 A 70% devaluation (depreciation) of BYN

Belarusians have lost purchasing power by holding

BYN instead of USD (or EUR etc)
 Developing the money demand function

L = f ( Y , i , i(exp), π, e(BYN/USD)(exp) )
+ – + – –
If the home currency is expected to devalue, people
will hold less home currency and switch to foreign
currency instead
GDP of Belarus, 2021

PY = 167,542 mill BYN

M2 = 23.255 bill. BYN

M3 = 54,351 mill. BYN

GDP of the Eurozone
M2/PY = 13.9%
PY = 15.250 trill. EUR
Why do Belarusians
‘hold’ so much less M2 = 14.585 trill. EUR
money as a share of
GDP???? M2/PY = 95.6%