MONEY DEMAND PRES

8/7/2019 MONEY DEMAND PRES.

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MONEY DEMANDAND SUPPLY

FUNCTIONS


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DEMAND FOR MONEY


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(a) Transaction Motive:

Keynes agreed with the classical theory that money is used as a medium ofexchange. So peoples demand for money is for the purpose of transactions and as

income rises, people have more transactions and people will hold more money.

(b) Precautionary Motive:In addition to holding money to carry out current transactions, Keynes observed

people hold money to be used in future for unexpected needs and emergencies.

Since this also depends on the amount of transactions people expect to make,money demand is again expected to rise with income.

(c) Speculative Motive:Keynes suggested that people also hold money as a store of wealth.

Because wealth is tied closely to income, the speculative motive for money

demand is related to income.

Keynes assumed that people stored wealth with either money or bonds. When

interest rates are high, rate would then be expected to fall and bond prices would

be expected to rise. So bonds are more attractive than money when interest rates

are high. When interest rates are low, they then would be expected to rise in the

future and thus bond prices would be expected to fall. So money is more attractive

than bonds when interest rates are low. So under the speculative motive, money

demand is negatively related to the interest rate

People hold money for three reason


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Determinants of Money Demand

DeterminantsofMoney Demand

Income Wealth Interest rate


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INCOME

MONEY IS NEEDED TO CARRY OUT TRANSACTIONS AND THE VALUE OF

THE TRANSACTIONS A PERSON WOULD HAVE OBVIOUSLY VARIES

DIRECTLY WITH HIS/ HER INCOME.


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Fishers equation: MV=PT

Cambridge equation: M=k PYWhere

M=money supply

V=velocity of circulation of money

P=general price

T=volume of transaction(=real income)

k=proportion of nominal income held in

money

y=output (real income)


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Money Demand


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Wealth


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WEALTH

James Tobin and Milton friedman

(1956) have imparted money

demanded a portfolio theory

approach.

The more wealth a person has,

the more he/she would save, andthe larger would be the size of

his/her portfolio.

Thus, wealth is a positive factor in

the money demand function.

However, since income includes

the income from wealth, it is often

taken as a surrogate measure ofthe asset holding power of

individual.


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INTEREST RATE


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Money Demand

1i


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BP=I/1 + i +I/(1+i)2 +I/(1+i)3 +..

Where BP=bond price

I=interest on bond each period

i=interest rate in the market

BP= I/i


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N1


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MONEY DEMAND FUNCTION

L/p = F(y, ,Pe)

F1>0>f1,f3

Where L=money(l quidity) demand in nominalterms

P=price level

Y=real income

i=interest rate (nominal)Pe=expected inflation rate


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SUPPLY OF MONEY


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Sources of Broad Money Supply in

India

Supply of money

CurrencyMultiple Creation

of Deposits

Money supply

functionBank deposits


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Source 1990-91 2000-01 2002-03

1. Net bank credit to government

y RBIs

y Other banks

2. Bank credit to commercial sectory RBIs

y Other banks

3. Net foreign assets of banking sector

y RBIs

y Other banks

4. Government currency liabilities to public

5. banking sectors net monetary liabilitiesother than demand & time deposits

y RBIs

y Other banks

6. Broad money (M3) (1+2+3+4-5)

1402

888

514

171863

1655

106

80

26

16

583

270

313

2658

5120

1539

3581

6792133

6659

2498

1972

526

54

1331

793

538

13,132

6781

1027

5574

906630

9036

3937

3582

355

71

2602

1271

1331

17,252

Sources of Broad Money Supply in

India


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CURRENCY


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BANK DEPOSITS


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MULTIPLE CREATION OF

DEPOSITS


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MONEY SUPPLY FUNCTION

M= C + D

H= C + R

Where M= money supply

C= currency with public

D= bank deposits

H= high-powered money

R= bank reserves


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Components of Reserve Money

component 1990-91 2000-01 2002-03

1. Currency in circulation

yWith public

yWith banks

2. Other deposits with RBI3. Bankers' deposits with RBI

4. Reserve money(1+2+3)

553

531

22

7

318

878

2182

2095

87

36

815

3033

2825

2710

115

32

836

3691


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Money Multipliers

tem At the end of financial year

1970-71 1980-81 1990-91 2002-03

1. Narrow money supply(M1)

2

.B

road moneys

upply (M3

3. High powered money (H)

4. Narrow money multiplier (1/3)

5. Broad money multiplier (2/3)

74

11048

1.54

2.29

234

558195

1.20

2.86

929

26

58878

1.06

3.03

4728

17

.7

52

3691

1.28

4.67

Note: this is net of the proceeds from the Resurgent Bonds (Rs.256.62

billion), which are deposited with the state Bank Of India since August

28, 1998.


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Sources of Reserve Bank

Source 1990-91 2000-01 2002-03

1. RBIs claims on

y Government

yCommercial & cooperative banks

yNational bank for agri. & rural dev.yCommercial sector

2. Net foreign assets ofRBI

3. Govt. currency liabilities to public

4. Net non-monitory liabilities of the RBI

5. Reserve money (1+2+3+4)

888

69

3163

80

16

270

878

1539

64

66

133

1972

54

793

3033

1207

14

5830

3582

71

1271

3691


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REGULATION OF MONEY SUPPLY AND

INSTRUMENTS OF MONETORY POLICY

InstrumentsofMonetary Policy

Open Market

Operation

Selectivecredit

control

Moral

persuasionBank rate

Cash reserve

ratio


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OPEN MARKET OPERATION


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CASH RESERVE RATIO


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BANK RATE


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SELECTIVE CREDIT CONTROLS


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MORAL PERSUASION


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Documents

MONEY DEMAND PRES