LectureBusinessCyclesMoneyandMonetarySystem.pptVIP

* * * * * * * * * * * * A rise in the price level increases the nominal quantity of money but doesn’t change the real quantity of money that people plan to hold. The interest rate The interest rate is the opportunity cost of holding wealth in the form of money rather than an interest-bearing asset. A rise in the interest rate decreases the quantity of money that people plan to hold. Real GDP An increase in real GDP increases the volume of expenditure, which increases the quantity of real money that people plan to hold. Financial innovation that lowers the cost of switching between money and interest-bearing assets decreases the quantity of money that people plan to hold. * * As we learned in chapter 4, the nominal interest rate is the opportunity cost of holding money (instead of bonds). Here, we are assuming the price level is fixed, so ? = 0 and r = i. * * * We are assuming a fixed supply of real money balances because P is fixed by assumption (short-run), and M is an exogenous policy variable. * * * * * In order for $500 billion in transactions to occur when the money supply is only $100b, each dollar must be used, on average, in five transactions. * * * Note: the theory doesn’t predict that the inflation rate will equal the money growth rate. It *does* predict that a change in the money growth rate will cause an equal change in the inflation rate. * * * * * * * * * * * First, point out the CPI (the dark blue line, right-hand scale): It’s risen tremendously over the past 40 years. If the common misperception were true, then the real wage should show exactly the opposite behavior. It doesn’t. Average hourly earnings (the red line) have increased roughly in tandem with the cost of living. As a result, inflation has not caused a downward trend in the real wage (hourly earnings in today’s dollars, green). The real wage isn’t constant - it varies within the $13 to $16 range - but there is no downward trend in the real wage over the long term.