Académique Documents
Professionnel Documents
Culture Documents
Reading
1. This set of slides
2. From the text material
Chapter - 5
r
M
D
D
Y
hr 1 / 2 /P
P -h =
= r
a
a
+
+
k.
k.
Yo
-
MD/P
As income Y increases, from Yo to Y
Tr. Demand for money rises at each level of interest rates;
hence total money demand also increases at each level of interest
rates.
As interest rate r rises, speculative demand for money falls
following the money demand curve;
hence total demand for money also falls.
MS1
MD
r0
MS
1
MDo
MD
r
r1
MD
A
ro
MS1
B
MS
1
MDo
MD
MD
A
MS1
B
MS
1
MD MDo
MD
MD
MS1
ro
r2
MS
1
MDo MD*MD
MS1
MD
E
ro
r2
D
MS
1
MDo MD* MD
r
LM
r2
r1
Y1
Y2
r
LM
r2
r1
MD < MS
B
Y1
D
MD > MS
Y2
r
LM
r2
Now as r to r2 SDM MD
below MS, the money market
moves to point B where MD < MS.
r1
Similarly on any point on the left
hand side of the LM curve, MD <
MS.
Now as r to r1 SDM MD
MD < MS
B
Y1
D
MD > MS
Y2
Monetary Policy
Monetary policy is defined as a
deliberate change in the money
supply made by the government.
Instruments of monetary policy (will be
discussed shortly) are changes in
- cash reserve ratio,
- reserve deposit ratio,
- bank rates
- repo rates
- or open market sells and purchase of
bonds.
MS1
MS2
MD
r1
r2
B
E
MS
MS
1
2
MD1 MD2MD
So.
An increase in money
supply causes interest
rates to to r2
Investment
C+I+G
AD
Y
If the economy was initially
at L (r1, Y1) it moves to L
(r2, Y2).
If the economy was initially
at M (r3, Y3) it moves to M
(r4, Y4).
Joining Land M we get a
new LM curve shifted down
and rightward from the initial
LM curve.
r
LM
L
r1
r2
r3
r4
LM
M
M
Y3 Y4Y1 Y2
Credit Creation
CIRCULATION OF MONEY
The
reserve
deposit
ratio =
1.
Depos
it
Rs.10
00
Individual
1
The cash
The
reserve
Central
Bank (RBI) ratio =
The
The
Commercial
Commercial
Bank (SBI
Bank (HDFC
Say)
Say)
Individual
2
Individual
3
Individual
4
CIRCULATION OF MONEY
The
reserve
deposit
ratio
1.
Deposit
Rs.1000
Individual
1
The
The cash
Central
reserve
Bank (RBI) ratio
The
The
Commercia
Commercial
l Bank
Bank (HDFC
(SBI Say)
Say)
3.
Balan
ce Rs.
200
2. Loans
Rs.800
Individual
2
Individual
3
Individual
4
CIRCULATION OF MONEY
The
Central
Bank (RBI)
The
The
Commercial
Commercial
Bank (SBI
Bank (HDFC
Say)
Say)
3.
Balance
6. Loans
Rs. 200 5. Deposit
2.
Loans
1.
Rs.640
Rs.800
Rs.800
Deposit
Rs.1000
Individual
1
Individual
2
Individual
3
Individual
4
4. Transaction of
Rs.800
Money in circulation = Rs. 1000 + Rs.800 + Rs.640
CIRCULATION OF MONEY
The
Central
Bank (RBI)
The
The
Commercial
Commercial
Bank (SBI
Bank (HDFC
7.
Say) 3.
Say)
Balance
Balance
Rs. 160
Rs.
200
1. Deposit
6. Loans
5. Deposit
2.
Loans
Rs.1000
Rs.640
Rs.800
Rs.800
Individual
1
Individual
Individual
Individual
2
3
4
4. Transaction of
Money in circulation =Rs.800
Rs. 1000 + Rs.800 + Rs.640
CIRCULATION OF MONEY
The
Central
Bank (RBI)
The
Commercial
Bank (SBI
Say) 3.
Balanc
e Rs.
1. Deposit
200
Rs.1000
2. Loans
Rs.800
Individual
1
The
Commercial
Bank (HDFC
7.
Say)
Balance
Rs. 160
6. Loans
5.
Rs.640
Deposit
Rs.800
Individual
Individual
Individual
2
3
4
4. Transaction of
Rs.800
8. Transaction of
Money in circulation = Rs. 1000
+ Rs.800 + Rs.640
Rs.640
CIRCULATION OF MONEY
The
Central
Bank (RBI)
The
The
Commercial
Commercial
Bank (SBI
Bank (HDFC
7.
Say)3.
Say)
Balance
Balanc
Rs. 160
9.
e
Rs.
1.
6.
Deposit
2.
Loans
200
Deposit
Loans
Rs.640
Rs.800
5.
Rs.1000
Rs.640
Deposit
Rs.800
Individual
Individual
Individual
Individual
1
2
3
4
4. Transaction of
Rs.800
8.
Transaction of
Rs.640
Money in circulation = Rs. 1000
+ Rs.800 + Rs.640
CIRCULATION OF MONEY
The
Central
Bank (RBI)
The
The
Commercial
Commercial
Bank (SBI
Bank (HDFC
7.
Say)
Say)
9. Deposit
Balance
Rs.640
Rs. 160
1.
10.
6.
2.
Depos
Loans
Loans
Loans
5.
it
Rs.512
Rs.640
Rs.80
Deposit
Rs.10
0
Rs.800
00
Individual
Individual
Individual
Individual
1
2
3
4
4. Transaction of
Rs.800
8. Transaction of
Monetary aggregates
&
money multiplier
M0:
Notes and coins (currency) in circulation and in bank vaults.
In some countries, such as the United Kingdom, M0 includes
bank reserves, so M0 is referred to as the monetary base,
or narrow money.
MB:
M0 + reserves which commercial banks hold in their
accounts with the central bank
MB is referred to as the monetary base or total currency or
Central Banks money.
This is the base from which other forms of money (like
checking deposits) are created and is traditionally the most
liquid measure of the money supply.
M1:
M1 includes funds that are readily accessible for spending.
M1 consists of:
(1) currency in circulation outside Central Banks, and the
vaults of depository institutions;
(2) traveler's checks of nonbank issuers;
(3) demand deposits (current account)
etc.
Bank reserves are not included in M1.
M3includes
1. M2
2. large time deposits
3. institutionalmoneymarketfunds,
4. short-term repurchase agreements and
5. other larger liquid.
Money multiplier
MM
= Total amount of money in circulation / central banks
monetary base
= M2/MB
In hand
Com.
Bank
vaults
With
RBI
Reserve
In hand
ar
t
e
on
M
se
a
yb
Bank deposit
2
M
c.M
d
In hand
.(1Com.c).Md
With
Bank
RBI
vaults
r
ta
e
on
M
Reserve
se
a
yb
2
M
In hand
Bank deposit
c.M
d
(1-c).Md
Md