demand for and supply of money-v

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Demand for Money,Demand for Money,

Supply of MoneySupply of Moneyand Monetaryand Monetary

PolicyPolicyDr. Shylajan, C.SDr. Shylajan, C.S


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Topicsof DiscussionTopicsof Discussion

Money SupplyMoney Supply

Money Stock MeasuresMoney Stock Measures

The Money Market: DD & SSThe Money Market: DD & SS The Demand for Money: Keynesian TheoryThe Demand for Money: Keynesian Theory

Determination of Interest Rates: ClassicalDetermination of Interest Rates: Classical vsvsKeynesian TheoryKeynesian Theory

Monitory Transmission Mechanism (ChangeMonitory Transmission Mechanism (Changein Monetary Policy and Impacts on Interestin Monetary Policy and Impacts on InterestRate, Consumption, Investment, AD andRate, Consumption, Investment, AD andGDP)GDP)

Nominal Vs Real Interest RatesNominal Vs Real Interest Rates


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Money SupplyMoney Supply--HowisitHowisit

defineddefined Money is a medium of exchange.Money is a medium of exchange.

It is what we use to make paymentsIt is what we use to make payments What is that we use to makeWhat is that we use to make

payments?payments?

Currency andCurrency and

Chequeable deposits with banksChequeable deposits with banks


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ComponentsofMoneyComponentsofMoney

SupplySupply Narrow Money (M1)Narrow Money (M1)

Broad Money (M3)Broad Money (M3) M1 = Currency with public + savingM1 = Currency with public + saving

(demand) deposits with banks + other(demand) deposits with banks + otherdeposistdeposist with RBI with RBI

M3 = M1 + time (fixed) deposits with banksM3 = M1 + time (fixed) deposits with banks


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Why dowe DemandWhy dowe Demand

MoneyMoney Role of Money in Classical Theory:Role of Money in Classical Theory:

Does not influence price, real interestDoes not influence price, real interest

rate and real income.rate and real income. Quantity theory of money: MV=PTQuantity theory of money: MV=PT

Keynesian Theory: 3 motivesKeynesian Theory: 3 motives

Transaction demand formoneyTransaction demand formoneyPrecautionary demand forPrecautionary demand formoneymoney

Speculative Demand forMoneySpeculative Demand for

Money


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MoneyMoneyTransaction demand formoneyTransaction demand formoney

PositivefunctionofincomePositivefunctionofincome NegativefunctionofinterestrateNegativefunctionofinterestrate

Precautionary demand formoneyPrecautionary demand formoney

PositivefunctionofincomePositivefunctionofincome

NegativefunctionofinterestrateNegativefunctionofinterestrate


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MoneyMoney Speculative Demand forMoneySpeculative Demand forMoney

Expected changeininterestratesExpected changeininterestrates Inshort, demand formoneyisaInshort, demand formoneyisanegativefunctionofinterestrateandnegativefunctionofinterestrateandpositivefunctionofincomepositivefunctionofincome

Stabilityof demand formoneyistheStabilityof demand formoneyisthekeytoproperconductofmonetarykeytoproperconductofmonetarypolicypolicy

MdMd==kY+fkY+f((ii))


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TheMoneyMarketandTheMoneyMarketandDeterminationofEquilibriumDeterminationofEquilibrium

RateofInterestRateofInterest

Interest rate: cost of borrowing moneyInterest rate: cost of borrowing money

How does the interest rate determined? (both inHow does the interest rate determined? (both inclassical and Keynesian theory)classical and Keynesian theory)

Supply of money and demand for moneySupply of money and demand for money Interest rate is set by the intersection of DD forInterest rate is set by the intersection of DD for

and SS of moneyand SS of money

MdMd=Ms=Ms


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Interest RatesInterest Rates

Consumers and investors rely onConsumers and investors rely on

money for purchase of goods andmoney for purchase of goods andservices.services.

Monetary authority can augment AD orMonetary authority can augment AD orreduce ADreduce AD bychangingmoneybychangingmoneysupplyand therebyinterestrates.supplyand therebyinterestrates.


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ChangeinMonetaryChangeinMonetary

PolicyPolicy Monetary authority may follow aMonetary authority may follow a

EasymonetarypolicyorEasymonetarypolicyor

TightmonetarypolicyTightmonetarypolicy

What is easy and tight monetary policy?What is easy and tight monetary policy?

Easy Monetary Policy money supplyEasy Monetary Policy money supplygrowth increases..interest rate declinegrowth increases..interest rate decline


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PolicyPolicy

Then what happens to demand forThen what happens to demand formoney?money?

Demand for money will increase andDemand for money will increase and

Then spending on goods and servicesThen spending on goods and servicesincreasesincreases


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PolicyPolicy Tight Monetary Policy..money supplyTight Monetary Policy..money supply

growth falls..interest rate increasesgrowth falls..interest rate increases

Then demand for money will fall..soThen demand for money will fall..sospending on goods and services fallsspending on goods and services falls

What kind of monetary policy RBI isWhat kind of monetary policy RBI isfollowing now?following now?


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ChangeinMonetaryChangeinMonetaryPolicyand ImpactsPolicyand Impacts--GraphicallyGraphically

ADAD--AS frameworkAS framework


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Nominal Vs RealNominal Vs Real

Interest RatesInterest Rates Real interest rate = Nominal interestReal interest rate = Nominal interest

rate minus rate of inflationrate minus rate of inflation

12% nominal interest rate12% nominal interest rate 3%3%inflation rate =9 % real interest rateinflation rate =9 % real interest rate


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TheMoneySupplyTheMoneySupply

ProcessProcess What causes change in money supply?What causes change in money supply?

M = C + DM = C + D

Where M is money stock, C is currency withWhere M is money stock, C is currency withpublic and D is bank depositspublic and D is bank deposits

Three groups influence money supplyThree groups influence money supplygrowthgrowth

1. Central bank1. Central bank2.Commercial Bank2.Commercial Bank

3. Public3. Public


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MoneyMultiplierMoneyMultiplier

Money multiplier (m) = M3/HMoney multiplier (m) = M3/H

M3 = Currency with Public + DepositsM3 = Currency with Public + Deposits

High powered money = Currency + ReservesHigh powered money = Currency + Reserves

Where m is money multiplierWhere m is money multiplier

M3 is total money supplyM3 is total money supply


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ControlofMoneySupplyControlofMoneySupply

by RBIby RBIInstrumentsofControlInstrumentsofControl

Changing Reserve Requirements (CRR, forChanging Reserve Requirements (CRR, forinstance)instance)

Changing the Bank RateChanging the Bank Rate

Direct Credit ControlsDirect Credit Controls


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MonetaryPolicyMonetaryPolicy

TransmissionMechanismTransmissionMechanismMoney supply changeMoney supply change

Effect on interest rate rEffect on interest rate r Impact on business spendingImpact on business spending

Impact on consumer spendingImpact on consumer spending Impact on Output or GDPImpact on Output or GDP


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MonetaryPolicyintheMonetaryPolicyintheADAD--AS FrameworkAS Framework

Two CasesTwo Cases

The case of increase in AD where potentialThe case of increase in AD where potentialoutput is not achievedoutput is not achieved

The case of increase in AD and its impact onThe case of increase in AD and its impact onoutput and price when potential output isoutput and price when potential output isreachedreached

Graphical approachGraphical approach


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MonetaryPolicyinIndiaMonetaryPolicyinIndia

Changes in major Monetary PolicyChanges in major Monetary PolicyMeasures:Measures:

Bank RateBank Rate

Cash Reserve Ratio (CRR)Cash Reserve Ratio (CRR)

Statutory Liquidity Ratio (SLR)Statutory Liquidity Ratio (SLR)


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MonetaryPolicyinMonetaryPolicyin

IndiaIndia Bank RateBank Rate in 1999:in 1999: 12 %12 % In 2003In 2003 :: 6 %6 %

In 2007In 2007 :: 6%6%

CRRCRR in 1991in 1991 :: 15 %15 % In 2004In 2004 :: 5 %5 %

In 2007In 2007 :: 7.50%7.50%

SLRSLR in 1992in 1992 :: 38.5 %38.5 % In 1997In 1997 :: 25 %25 %

In 2007In 2007 :: 25 %25 %


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SummarySummary


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demand for and supply of money-v

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