goods and services determines the standard of living of its citizens
2. In the SR, AD influences the amount of
goods and services that a country produces
Advances in Business Cycle Model
The neutrality of money
---money, not only in the LR, but also in the SR, is neutral
---money supply is endogenous (Y↑MS↑)
How costly is inflation, and how costly is reducing it? How big a problem is government debt?
2. 3.
4.
Conclusion
“If all economists were laid end to end, they would not reach a conclusion.” --- George Bernard Shaw
Financial Innovation & Near Money
Near money
---non-monetary assets that have acquired some of the liquidity of money
---complicates monetary policy by making money demand unstable
Advances in Business Cycle Model
All workers perform cost-benefit analysis
when deciding whether to work or to enjoy leisure.
The inter-temporal substitution of labor
--- the role as a store of value --- offers a different combination of risk and return than other assets (safe/normal return) The D for M depends on the risk and return offered by M and by the various assets households can hold instead of M
explains why employment and output fluctuate.
Advances in Business Cycle Model
The importance of technology shocks
Technology determines the ability to turn inputs into outputs. Therefore, the economy experiences fluctuations in technology and that these fluctuations in technology cause fluctuations in output and employment
The theory of real business cycles
The economics of Robinson Crusoe --- fluctuations in Y, u, C, I, and productivity are all the natural and desirable response of an individual to the inevitable changes in his environment --- fluctuation has nothing to do with monetary policy, sticky prices, or any type of market failure
Money Demand
Transaction theories of money D
--- the role as a medium of exchange --- best explains why people hold narrow measures of money --- although returns are low, benefits of making transactions more convenient are important
What We Know?
3. In the LR, the rate of M growth determines
the inflation rate, but it does not affect the unemployment rate
4. In the SR, policymakers who control
Advances in Business Cycle Model
The flexibility of wages and prices
--- wages and prices adjust quickly to clear markets
What We Know?
1. In the LR, a country’s capacity to produce
“The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, which helps its possessor to draw correct conclusions.” --- John Maynard Keynes
Money Supply
M/B = (C+D) / (C+R)
M/B = (cr+1) / (cr + rr) M = [(cr+1) / (cr + rr)]*B
M=m*B
m: the money multiplier
Money Supply

Money suppse (B): + ② Reserve-deposit ratio (rr): ③ Currency-deposit ratio (cr): -
Money Demand

Baumol-Tobin model of cash management
Money holding over the year
Y M holding M holding
1
time
1
time
Money Demand
Total cost of trips to the bank:
① ②
Forgone interest: i * (Y/2N) Cost of trips: F * N
Money Demand

Minimize C
N*
FY 2i
iY 2F
Y / 2N*

① ② ③
Money demand depends on
Fixed cost for trips to the bank: + Expenditure: + i-rate: -
Intermediate Macroeconomics
Lecture 19
Money Supply
100%-reserve banking Fractional-reserve banking
Money Supply
A model of money supply
The monetary base: C+R The reserve-deposit ratio: rr = R/D The currency-deposit ratio: cr = C/D Money supply: M = C + D Monetary base: B = C + R
Money Demand
Example:
(M / P) L(rs , rb , ,W )
d e
Are portfolio theories useful for studying money D?
Depends… Narrow measures of M --Broad measure of M --- plausible M is a dominated asset (as a store of value, it exists alongside other assets that are always better)
Money Supply

Instruments of monetary policy
① Open-market operation ② Reserve requirement ③ Discount rate
Money Demand
Portfolio theories of money demand
Financial Innovation & Near Money
Taylor’s Rule & Allen Greenspan
Nominal i-rate of federal funds = 2 + 0.5*(inflation rate – 2) – 0.5*(GDP*-GDP)