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11 Cards in this Set
- Front
- Back
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What is velocity?
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the number of times per year that an "average dollar" is spent on goods and services, given by nominal GDP/money stock.
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What is the equation of exchange?
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Relates the money supply and nominal GDP: M X V = P X Y
But this is just an arithmetic identity. To transform it into an economic theory, must assume that velocity is constant. |
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Why is the equation of exchange so helpful? What is the problem with it?
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Much simpler than the Keynesian model. This one says M X V = P X Y, which is saying that delta(M) + delta (V) = delta(P) + delta(Y). If you want to grow Y by a certain amount, can just vary M. The problem is that it assumes that V is constant.
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What are some determinants of velocity?
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1. Efficiency of the Payments system - ease and speed with which it is possible to exchange money for other assets, credit cards reduce need to hold money balances, velocity goes up.
2. Interest Rates - higher rate of interest, greater the opportunity cost of holding money, people want to hold smaller cash balances, existing stock of money circulates faster, V increases. |
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What directly undercuts the quantity theory of money as a guide for monetary policy?
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expansionary monetary policy, increases bank reserves and money supply, decreases interest rate, V falls. Then M X V should increase by a smaller percentage than does M itself.
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What is monetarism?
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uses equation of exchange to organize and analyze macroeconomic data. The equation is
delta(M) + delta (V) = delta(P) + delta(Y) What you want to do is manipulate Y. |
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So monetary policy can affect interest rates. But what about fiscal policy?
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As G goes up or T goes down, interest rates go up.
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Expansionary fiscal policy raises interest rates. How would this affect Investment spending? What implications does this have on the size of the multiplier.
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Reduces I, pulling aggregate demand curve inward again. which means that the size of the multiplier is exaggerated.
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Why do you want to lower government budget deficit?
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Can spur investment. lower spending and higher taxes, leading to lower interest rates, leading to higher investment.
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Should we rely on fiscal or monetary policy?
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Fiscal policy - changes in G or personal taxes - affects aggregate demand more promptly than do monetary policy actions.
Policy lags are normally much shorter for monetary policy than for fiscal policy. Monetary policy - decided on by FOMC which meets 8 times a year - monetary decisions are made frequently - can execute buying and selling of Treasury bills instantly. |
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Should the Fed control money supply or interest rates?
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Look at the graph of interest rate against money supply. The Fed cannot control M and r at the same time. When the demand curve for money shifts outward, the Fed must tolerate a rise in interest rates, a rise in the money stock, or both. If it tries to keep M steady, then r will rise even more. Conversely, if it tries to stabilize r, then M will rise even more.
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