pratclif.com In our world when you need to carry out a market transaction — whether you want to buy or to sell some good or service — you have to have money yourself (if you want to buy) or you have to deal with a purchaser who has money himself (if you want to sell). In a barter economy, ie. an economy without the social convention of money, market exchange woul require the so-called coincidence of wants: You would have to have physically in your possession some good or service that another person wants, and that person would have to have in his or her possession some good or service that you want. As this figure shows, finding consumption goods to satisfy the coincidence of wants would be remarkably complicated; very quickly without money, an extraordinary amount of time and energy would be spent simply arranging the goods one needed to trade.
There is one other feature worth noting. The same assets that serve as the most common fortn of readily spendable purchasing power also serve as units of account. Dollars or euros or yen are not only what we use to settle transactions but also what we use to quote prices to one another. At some times and places the functions of money as a medium of exchange and as a unit of account were separated, but today they almost invariably go together. This is a potential cause of trouble. Anything that alters the real value of the domestic money in terms of its purchasing power over goods and services will also aler the real terms of existing contracts that use money as the unit of account. The effect of changes in the price level on contracts that have used the domestic money as a unit of account is a principal source of the social costs of inflation and deflation. The effect of changes in the exchange rate on contracts that have used foreign monies as units of account is a principal source of the social costs of currency crises.
To an economist, "money" is wealth that is held in a readily spendable form. Money is the kind of wealth that you can use immediately to buy things because other people/institutions/shops will accept it as payment. Money is useful because in its absence we would have a barter economy and market exchanges would require the so-called coincidence of wants. Without money, an extraordinary amount of time and energy would be spent simply arranging the goods one needed to trade.
The same assets that serve as the most common form of readily spendable purchasing power also serve as units of account. Dollars or euros or yen are not only what we use to settle transactions but also what we use to quote prices to one another. This is a potential cause of trouble. The effect of changes in the price level on contracts that have used the domestic money as a unit of account is a principal source of the social costs of inflation and deflation. The effect of changes in the exchange rate on contracts that have used foreign monies as units of account is a principal source of the social costs of currency crises.
People have a demand for money just as they have a demand for any other good. They want to hold a certain amount of their wealth as money, ie. in the form of readily usable purchasing power, because money is useful in everyday life. The more money you have in your property, the easier it is for you to buy things. Too little money makes life difficult. You have to waste time running to the bank for extra money or you have to waste energy and time selling elements of your property to get money so as to carry out normal daily transactions.
But don't want to have too much of your wealth in the form of readily usable purchasing power. Money staying in your pocket could earn interest in a bank, and is not earning such interest. Money you need not spend for five years could earn a return as a certificate of deposit or as an investment in the stock market rather than stay in your pocket, at home in a cupboard, or at your bank in your current account.
This Figure summarizes the reasons for and the opportunity cost of holding money.
The higher the flow of spending, the more money the households and businesses in the economy will want to hold. How much more? That depends on the transactions technology of the economy: what businesses will take credit cards, how easy it is to get checks approved and cashed, how long the float is, and so forth. In this section of the chapter, however, we ignore all other determinants of money demand and focus on the flow of spending as the principal determinant of money demand.
The theory that the only important determinant of the demand for money is the flow of spending is called the quantity theory of money. It is summarized in either :
In either form of the quantity equation, PxY represents the total nominal flow of spending ie. output or real GDP, times the current price level index. For each dollar spent on goods and services, households hold 1/V dollars worth of money. The parameter V is the velocity of money — a constant, or perhaps growing slowly and predictably (in this section of the chapter only — later on, things will be more complicated!). The velocity of money is a measure of how "fast" money moves through the economy: how many times a year the average unit of money shows up in someone's income and is used to buy a final good or service that counts in GDP ie. Y.
Together, the quantity theory of money and the full-employment assumption allow us to determine the price level in the flexible-price model of the macroeconomy. Real GDP Y is equal to potential output: Y = Y*. The velocity of money V is determined by the sophistication of the banking system and the social conventions that govern payments and settlements of transactions. For the "Ml" concept of money — ie. cash in currencies plus bank current accounts — the current velocity V is about 8.5: Businesses and households want to hold about $1 of their wealth in the form of M1 for every $8.50 of real GDP produced. Changes in financial sophistication have raised velocity over time. In the years immediately after World War II, the M1 velocity of money was only 3. For the M2 concept, velocity is considerably lower (see this figure).
Thus if we know real GDP Y, the velocity of money V and the money stock M, we can calculate that the price level is P=MV/Y
Box 1 presents an example of such a quantity-theory calculation.
Should the price level be momentarily higher than the quantity equation predicts, households and businesses will notice that they have less wealth in the form of readily spendable purchasing power than they want. They will cut back on purchases for a little while to build up their liquidity. As they cut back on purchases, sellers will note that demand is weak and will cut their prices, so the price level will fall.
Should the price level be momentarily lower than the quantity equation value, households and businesses will note that they have more wealth in the form of money than they want, so they will accelerate their purchases to reduce their money balances. Sellers will note that demand is strong and will raise their prices, so the price level will rise. As long as prices are flexible, the economy's price level will remain at its quantity-theory equilibrium. Transitory fluctuations in the velocity of money mean that day-to-day or even year-to-year changes in the money stock are not mirrored in equivalent proportional changes in the price level. But on a decade-to-decade time scale the quantity theory of money is a very reliable guide to and predictor of large movements in prices.
Using the quantity theory in this way requires that we know the level of the money stock, however. What determines the level of the money stock?
Determination of the money stock is the basic task of monetary policy. In the United States the Federal Reserve, the nation's central bank, determines the money stock. The central bank directly determines the monetary base, the sum of currency in circulation and of deposits at the Federal Reserve's 12 branches.
When the central bank wants to reduce the monetary stock of the economy, it sells short-term government bonds and accepts currency or checks from deposits at its regional branches as payment. The currency is then removed from circulation and stored in a basement somewhere; the deposits the central bank receives as payment are then erased from its books. Thus the monetary base declines.
When the Federal Reserve wants to increase the monetary base, it buys short-term government bonds, paying for them with currency that is printed or by crediting the seller with a deposit at the Federal Reserve. These transactions are called open-market operations, because the Federal Reserve buys or sells bonds on the open market. The procedures that govern when and how the U.S. central bank, the Federal Reserve, undertakes these transactions are decided at periodic meetings of the Federal Open Market Committee (FOMC).
How does the Federal Reserve control the monetary base?
Mis à jour le 26/03/2020 pratclif.com
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