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CHAPTER 22

CHAPTER 22. The Demand for Real Money Balances and Market Equilibrium. Average holdings of real money balances over the month. $2,100 – $1,100 – $100 –. Transactions Demand. Transactions Demand. Time (Months). Real Money Holdings by a Typical Household. Precautionary Demand.

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CHAPTER 22

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  1. CHAPTER 22 The Demand for Real Money Balances and Market Equilibrium

  2. Average holdings of real money balances over the month $2,100 – $1,100 – $100 – Transactions Demand Transactions Demand Time (Months) Real Money Holdings by a Typical Household Precautionary Demand

  3. How Households and Firms Decide What Amount of Real Balances to Hold • Benefits of Holding • Real Money Balances • Ability to provide a stream of services because money is available when needed to make payments, thus avoiding the need to pay a brokerage fee to get money and the inconvenience of waiting for money to arrive • Interest earned on checkable deposits (for households) • Cost of Holding • Real Money Balances • Forgone interest that nonmonetary balances would have earned versus Decision Rule Hold real money balances as long as the benefits are greater than the costs

  4. Interest Rate (Percent) Demand Real Money Balances A Demand Curve for Real Money Balances

  5. Interest Rate Decrease in Demand Decrease in Demand D' D D'' Real Money Balances The Demand for Real Money Balances

  6. An Increase in … Will Cause the Demand for Money to … Income Increase Wealth Increase Payment technologies Decrease Expected inflation Decrease Risk of other financial assets Increase Liquidity of other financial assets Decrease A Decrease in … Will Cause the Demand for Money to … Income Decrease Wealth Decrease Payment technologies Increase Expected inflation Increase Risk of other financial assets Decrease Liquidity of other financial assets Increase Factors That Affect the Demand for Real Money Balances

  7. Interest Rate (Percent) Demand Real Money Balances Equilibrium in the Market for Real Money Balances Supply A 6

  8. MS MS' Interest Rate (Percent) Increase Decrease Real Money Balances A Change in the Supply of Real Balances

  9. MS MS' Interest Rate (Percent) A B Demand Real Money Balances Increases in the Supply of Real Money Balances

  10. MS Interest Rate (Percent) Real Money Balances Expansionary Open Market Operations May Eventually Lead to Increases in Demand MS' A C D' B D

  11. Other Changes Can Also Shift the Demand for Real Balances Curve MS Interest Rate (Percent) D' D Real Money Balances

  12. $2,000 $1,000 30 Days The Number of Broker Calls Per Month and the Average Holdings of Real Balances (Transactions Demand for Real Balances) Income = $2,000/month Price Level = 1 Average Daily Holding of Funds $1,000 Average Daily Holding of Funds $500 30 Days $666.67 Average Daily Holding of Funds $333.33 30 Days

  13. Benefits and Costs of Additional Calls to the Broker (A) Transactions Money if Call is Not Made (B) Demand for Money if Call is Made Benefit: Interest on Additional Bonds Held Call (A) – (B) 0 1 2 3 4 $1,000 1,000 500 333 250 — $500 333 250 200 — $500 167 83 50 $2.50 ($500 X .005) .83 ($167 X .005) .43 ($83 X .005) .25 ($50 X .005)

  14. (A) Transactions Demand for Money if Call is Not Made (B) Transactions Demand for Money if Call is Made Benefit: Interest Earned on Additional Bonds Held Call (A) – (B) 0 1 2 3 4 $1,000 1,000 500 333 250 — $500 333 250 200 — $500 167 83 50 $5.00 ($500 X .01) 1.67 ($167 X .01) .83 ($83 X .01) .50 ($50 X .01) Benefits and Costs of Calls to the Broker if the Interest Rate Increases to 1 Percent Per Month

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