Finc 402 Monetary Theory Ob Marvin

Lecturer: Dr.
Edward Asiedu, UGBS

Contact Information: edasiedu@ug.edu.gh
College of Education
Department of Distance Education
2017/2018
Session Overview
In this session, we will explore;

• the functions of money,
• why and how it promotes economic efficiency,
• how its form have evolved over time
Dr. Edward Asiedu Slide 2

Session Outline
The key topics to be covered in the session are as follows:
• Why should accountants and financial analysts be interested in

monetary theory?
• Describe what money is and was
• List and summarize the key functions of money

Reading List
• Frederic S. Mishkin, The Economics of Money,
Banking, and Financial Markets, 7th or 9th edition
(Addison Wesley: New York).
• Walsh, Carl E. Monetary theory and policy. MIT press,
2010.

Topic one
WHY SHOULD ACCOUNTANTS AND

FINANCIAL ANALYSTS BE INTERESTED IN
MONETARY THEORY?
Why should accountants and financial analysts
be interested in monetary theory?
• Majority of us are going to be working with financial institutions
(Financial intermediaries, banks, insurance companies, pension
funds, mutual funds etc.).
Financial intermediaries: institutions that borrow funds from people

and give loans to others.
• Banks: institutions that accept deposits and make loans.
• And therefore it is important to understand how financial

institutions work.
• Also, importantly, to understand the role of money in the

economy.
• Money, also referred to as the money supply, is defined as anything
that is generally accepted in payment for goods or services or in the
repayment of debts.
• Money plays a key role in generating business Cycles (recessions

and booms).
• Business Cycles are upward and downward movement of aggregate

output produced in the economy. (follow on screen description how
many impacts economic growth)
• Business cycles affect all of us in immediate and important ways.

When output is rising, for example, it is easier to find a good job;
when output is falling, finding a good job might be difficult.

• Recession (unemployment) and economic booms affect all of

us.
• Changes in the money supply impacts changes in aggregate

economic activity and inflation.

Topic Two
ROLE AND NATURE OF MONEY

Role and nature of money
What Is Money?
• Money has been different things at different times;
however, it has always been important to people and
to the economy.
• To understand the effects of money on the economy,

we must understand exactly what money is.
• We will explore the key functions of money, looking at

why and how it promotes economic efficiency.
Meaning of Money?
• As the word money is used in everyday conversation, it can mean

many things, but to economists, it has a very specific meaning.
• Economists define money (also referred to as the money supply) as

anything that is generally accepted in payment for goods or services
or in the repayment of debts.
• Currency, consisting of cedi bills, euro bills, dollar bills and coins,
clearly fits this definition and is one type of money.
• When most people talk about money, they’re talking about

currency (paper money and coins).

Meaning of Money?
• To define money merely as currency is much too narrow for

economists.
• Because cheques are also accepted as payment for purchases,

checking/current account deposits are considered money as
well.
• An even broader definition of money is often needed,

because other items such as savings deposits can in effect
function as money if they can be quickly and easily converted
into currency or checking/current account deposits.

Meaning of Money?
• To complicate matters further, the word money is
frequently used synonymously with wealth. When people
say, “Mike is rich—he has an awful lot of money,” they
probably mean that Mike has not only a lot of currency
and a high balance in his checking account but has also
stocks, bonds, four cars, three houses, and a yacht.
• Thus while “currency” is too narrow a definition of

money, this other popular usage is much too broad.

Topic Three
FUNCTIONS OF MONEY

Functions of Money
• Whether money is kola or shells or rocks or gold or

paper, it has three primary functions in any
economy:
• Medium of Exchange
• Unit of account
• Store of value

Functions of Money
Medium of Exchange
• In almost all market transactions in our economy, money in
the form of currency or cheque is a medium of exchange; it is
used to pay for goods and services.
• The use of money as a medium of exchange promotes

economic efficiency by minimizing the time spent in
exchanging goods and services.
• HOW??
• Use the scenario of a Finance/Economics Professor, who can
do just one thing well: give brilliant monetary theory lectures.

Functions of Money
Medium of Exchange
• In a barter economy, if the Professor wants to eat, she must
find a farmer who not only produces the food he likes but
also wants to learn economics. As you might expect, this
search will be difficult and time-consuming, and Ellen might
spend more time looking for such an economics-hungry
farmer than she will be teaching.
• It is even possible that she will have to quit lecturing and go

into farming herself. Even so, she may still starve to death.

Functions of Money
Medium of Exchange
• The time spent trying to exchange goods or services is called a
transaction cost.
• In a barter economy, transaction costs are high because

people have to satisfy a “double coincidence of wants”—they
have to find someone who has a good or service they want
and who also wants the good or service they have to offer.
• The use of money as a medium of exchange there promotes

economic efficiency by minimizing the time spent in
exchanging goods and services.

Functions of Money
Medium of Exchange
For a commodity to function effectively as money, it has to meet
several criteria:
• It must be easily standardized, making it simple to ascertain its

value;
• It must be widely accepted;
• It must be divisible, so that it is easy to “make change”;
• It must be easy to carry; and
• It must not deteriorate quickly.
Examples of money (in history): Tobacco, whiskey, cigarettes used in

prisoner-of-war camps, beads etc

Functions of Money
Unit of Account
• The second role of money is to provide a unit of account; that

is, it is used to measure value in the economy. We measure
the value of goods and services in terms of money.
• Just as we measure weight in terms of kilograms or distance in

terms of kilometers.
• To see why this function is important, let’s look again at a

barter economy where money does not perform this function.

Functions of Money
Unit of Account
• If the economy has only three goods—say, Plantain, books, and
pens—then we need to know the price (value) of a kilo of plantain
in terms of books or pens. In other words, how many kilos of
plantain you have to pay for a book or pen or how many books
(exercise book, textbook etc.) you have to pay for a pen.
• This will indeed become more complicated with more than three
goods.
• The solution to the problem is to introduce money into the

economy and have all prices quoted in terms of units of that money

Functions of Money
Unit of Account
• We can see that using money as a unit of account reduces

transaction cost
• The benefits of this function of money grow as the economy

becomes more complex.

Functions of Money
Store of Value
• Money also functions as a store of value; it is a repository

of purchasing power over time.
• A store of value is used to save purchasing power from

the time income is received until the time it is spent.
• This function of money is useful, because most of us do

not want to spend our income immediately upon
receiving it, but rather prefer to wait until we have the
time or the desire to shop.

Functions of Money
Store of Value
• Money is not unique as a store of value; any asset—whether

money, stocks, bonds, land, houses, art, or jewelry—can be
used to store wealth.
• Many such assets have advantages over money as a store of

value: They often pay the owner a higher interest rate than
money, experience price appreciation, and deliver services
such as providing a roof over one’s head.
Question: If these assets are a more desirable store of value than

money, why do people hold money at all?

Functions of Money
Store of Value
• The answer to this question relates to the important economic

concept of liquidity, the relative ease and speed with which an asset
can be converted into a medium of exchange.
• Liquidity is highly desirable. Money is the most liquid asset of all

because it is the medium of exchange; it does not have to be
converted into anything else in order to make purchases. Other
assets involve transaction costs when they are converted into
money.
Examples?

Functions of Money
Thank You

Lecturer: Dr. Edward Asiedu, UGBS
Contact Information: edasiedu@ug.edu.gh
2017/2018
Session Overview
In this session, we will explore;

• Evolution of the payment system,
• Are we approaching a cashless economy?
• Measuring money in the economy

Session Outline
The key topics to be covered in the session are as follows:
• Identify different types of payment systems

• Compare and contrast the M1, M2 and M2+ money monetary
aggregates

Reading List
2010.

Topic One
EVOLUTION OF THE PAYMENTS SYSTEM

Evolution of the Payments System
• We can obtain a good picture of the functions of

money and the forms it has taken over time by
looking at the evolution of the payments system, the
method of conducting transactions in the economy.

1. Commodity Money
• An object that clearly has value to everyone is a likely candidate to
serve as money, and a natural choice is a precious metal such as
gold or silver. Money made up of precious metals or another
valuable commodity is called commodity money.
2. Fiat Money
• The next development in the payments system was paper currency
(pieces of paper that function as a medium of exchange).
 Fiat money: paper money decreed by governments as legal tender.

2. Fiat Money (continuation)

• Major drawbacks of paper currency and coins are that they
are easily stolen and can be expensive to transport in large
amounts because of their bulkiness.
• To combat this problem, another step in the evolution of the

payments system occurred with the development of modern
banking: the invention of cheques.

3. Cheques
• an instruction to your bank to transfer money from your
account.
• Cheques allow transactions to take place without the need

to carry around large amounts of currency. The
introduction of checks was a major innovation that
improved the efficiency of the payments system.

3. Cheques
There are, however, two problems with a payments system
based on cheques.
 First, it takes time to get checks from one place to another, a

particularly serious problem if you are paying someone in a
different location who needs to be paid quickly.
 In addition, if you have a current account, it usually takes

several business days before a bank will allow you to make
use of the funds from a check you have deposited.

4. Electronic Payment
e.g. online bill pay
• Necessitated by the development of inexpensive computers

and the spread of the Internet.

5. E-Money (electronic money):

Electronic money (or e-money), is money that exists only in
electronic form. The first form of e-money was the debit card or
bank card as usually called in Ghana.
Debit cards or bank cards enable consumers to purchase goods

and services by electronically transferring funds directly from
their bank accounts to a merchant’s account.
At most supermarkets, for example, you can swipe your debit

card through the card reader at the checkout station, press a
button, and the amount of your purchases is deducted from your
bank account.

5. E-Money (electronic money):
• Debit or bank card

• Stored-value card (smart card)
• E-cash
• Mobile money

Are We Headed for a Cashless Society?
• Predictions of a cashless society have been around for

decades, but they have not come to fruition.
• Although e-money/mobile money might be more

convenient and efficient than a payments system based
on paper, several factors work against the disappearance
of the paper system.
 Can you think of reasons that can impede e-money

dominance?

Topic Two
MEASURING MONEY IN AN ECONOMY

Measuring Money
• How do we measure money? Which particular assets can

be called “money”?
• Central banking authority responsible for monetary

policy has conducted many studies on how to measure
money.
• The problem of measuring money has recently become

especially crucial because extensive financial innovation
has produced new types of assets that might properly
belong in a measure of money.

Measuring Money
• Central banks in many countries have modified their

measures of money several times and has settled on
the following measures of the money supply, which are
also referred to as monetary aggregates.
Construct monetary aggregates using the concept of liquidity:
 M1 or Narrow money (most liquid assets) = currency +

traveler’s checks + demand deposits + other checkable
deposits.

Measuring Money
 M2 or broad money (adds to M1 other assets that are not so

liquid) = M1 + small denomination time deposits + savings
deposits and money market deposit accounts + money market
mutual fund shares.
 In Ghana there is also M2+ which is M2 plus foreign currency

deposits

Measuring Money
 Table 1 Measures of the Monetary Aggregates.

Measuring Money
M1 vs. M2
• Does it matter which measure of money is considered?
• M1 and M2 can move in different directions in the short-run

(see figure).
• Conclusion: the choice of monetary aggregate is important for

policymakers.

Measuring Money
 Figure 1 Growth Rates of the M1 and M2 Aggregates, 1960–2011.

Measuring Money
 Figure 2 Broad Money for Ghana, 2005–2016.
Source: International Monetary Fund, Broad Money for Ghana© [GHAFMBGDPPT],

retrieved from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/GHAFMBGDPPT, February
Slide 22
8, 2017.
Dr. Edward Asiedu
Contact Information: easiedu1@gmail.com
2017/2018
Session Overview
• By the end of this sections students should be
able;
• To examine how financial markets such as
bond, stock and foreign exchange markets
work
• To examine how financial institutions such as
banks, investment and insurance companies
work
• To examine the role of money in the economy
Session Outline
The key topics to be covered in the session are as
follows:
• An Overview Of The Financial System And Some
Basic Concepts.
• Function of Financial Markets.
• Structure of Financial Markets.
• Internationalization of Financial Markets
• Function of Financial Intermediaries: Indirect
Finance
• Regulation of the Financial System
Reading List

2010

Topic one
AN OVERVIEW OF THE FINANCIAL SYSTEM

AND SOME BASIC CONCEPTS

An Overview Of The Financial System And Some Basic
Concepts
The Bond Market and Interest Rates

• A security (financial instrument) is a claim on the issuer’s
future income or assets.
• A bond is a debt security that promises to make payments

periodically for a specified period of time.
• An interest rate is the cost of borrowing or the price paid for

the rental of funds.

An Overview Of The Financial System
And Some Basic Concepts
• The Stock Market
• Common stock represents a share of ownership in a

corporation
• A share of stock is a claim on the residual earnings and

assets of the corporation

Money, Business Cycles and Inflation
• The aggregate price level is the average price of

goods and services in an economy
• A continual rise in the price level (inflation) affects
all economic players
• Data shows a connection between the money supply
and the price level

Figure 5 Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries, 2000-2010
Source: Based on International Financial Statistics. w w w .im fstatistics.org/ im f.

Money and Interest Rates
• Interest rates are the price of money
• Prior to 1980, the rate of money growth and the

interest rate on long-term Treasury bonds were
closely tied
• Since then, the relationship is less clear but the rate of

money growth is still an important determinant of
interest rates

The Foreign Exchange Market
• The foreign exchange market is where funds are

converted from one currency into another
• The foreign exchange rate is the price of one currency
in terms of another currency
• The foreign exchange market determines the foreign
exchange rate

Fiscal Policy and Monetary Policy
• Monetary policy is the management of the money supply

and interest rates
• Conducted by the Central Bank(Bank of Ghana)
• Fiscal policy deals with government spending and taxation

• Budget deficit is the excess of expenditures over revenues for
a particular year
• Budget surplus is the excess of revenues over expenditures for
a particular year
• Any deficit must be financed by borrowing

Topic Two
FUNCTION OF FINANCIAL MARKETS

Function of Financial Markets
• Perform the essential function of channeling funds

from economic players that have saved surplus funds
to those that have a shortage of funds
• Direct finance: borrowers borrow funds directly from

lenders in financial markets by selling them securities

• Promotes economic efficiency by producing an

efficient allocation of capital, which increases
production
• Directly improve the well-being of consumers by

allowing them to time purchases better

Figure 1 Flows of Funds Through the Financial System

Topic Three
STRUCTURE OF FINANCIAL MARKETS

Structure of Financial Markets
• Debt and Equity Markets
 Debt instruments (maturity)

 Equities (dividends)
• Primary and Secondary Markets
 Investment Banks underwrite securities in primary

markets
 Brokers and dealers work in secondary markets
• Exchanges and Over-the-Counter (OTC) Markets
 Exchanges: NYSE, Chicago Board of Trade

 OTC Markets: Foreign exchange, Federal funds
• Money and Capital Markets
 Money markets deal in short-term debt instruments

 Capital markets deal in longer-term debt and
equity instruments

Table 1 Principal Money Market Instruments

Table 2 Principal Capital Market Instruments

Topic Four
INTERNATIONALIZATION OF FINANCIAL MARKETS

Internationalization of Financial
Markets
• Foreign Bonds: sold in a foreign country and denominated in
that country’s currency
• Eurobond: bond denominated in a currency other than that of
the country in which it is sold
• Eurocurrencies: foreign currencies deposited in banks outside
the home country
• Eurodollars: U.S. dollars deposited in foreign banks
outside the U.S. or in foreign branches of U.S. banks
• World Stock Markets
– Also help finance the federal government
Topic Five
FUNCTION OF FINANCIAL INTERMEDIARIES:

INDIRECT FINANCE

Function of Financial Intermediaries:
Indirect Finance
• Low er transaction costs (tim e and m oney sp ent
in carrying ou t financial transactions)
• Econom ies of scale
• Liqu id ity services
• Red u ce the exposu re of investors to risk

• Risk Sharing (Asset Transform ation)
• Diversification

Indirect Finance
• Deal w ith asym m etric inform ation problem s

• (before the transaction) Ad verse Selection: try to
avoid selecting the risky borrow er
• Gather inform ation abou t potential borrow er.
• (after the transaction) Moral H azard : ensu re
borrow er w ill
• not engage in activities that w ill prevent him / her to
repay the loan. Sign a contract w ith restrictive
covenants.

Indirect Finance
• Conclu sion:
– Financial interm ed iaries allow “ sm all” savers and
borrow ers to benefit from the existence of financial
m arkets.

Indirect Finance
• Table 3 Prim ary Assets and Liabilities of Financial Interm ed iaries

Indirect Finance
Table 4 Princip al Financial Interm ed iaries and Valu e of Their Assets

Topic Six
REGULATION OF THE FINANCIAL SYSTEM

Regulation of the Financial System
• To increase the inform ation available to

investors:
• Red u ce ad verse selection and m oral hazard
problem s
• Red u ce insid er trad ing (SEC).

• To ensure the soundness of financial intermediaries:

• Restrictions on entry (chartering process).
• Disclosure of information.
• Restrictions on Assets and Activities (control holding
of risky assets).
• Deposit Insurance (avoid bank runs).
• Limits on Competition (mostly in the past)
• Branching
• Restrictions on Interest Rates

Table 5 Principal Regulatory Agencies of the U.S. Financial System

2017/2018
Session Overview
After going through this session, students should be able
• Summarize how conventional monetary policy tools

are implemented and the advantages and limitations
of each tool.
• Explain the key monetary policy tools that are used
when conventional policy is no longer effective.

Session Outline
The key topic to be covered in the session is tools of
monetary policy.
More specifically:
• The Money Supply
• Open Market Operations
• Discount Rate.
• Reserve Requirements

Reading List

2010
Dr Edward Asiedu Slide 4

Tools of Monetary Policy
• Central banks usually have an array instruments for
conducting monetary policy
• The main ones are:

• Open market operations
• Reserve requirement policy
• Discount rate policy

Topic one
MONEY SUPPLY

Money Supply
• The supply of money in an economy is determined
by the banking system
 Directly controlled by the central bank through

monetary policy
 Indirectly influenced by commercial banks (and the

public) through the deposit creation process
• The Central Bank controls the supply of money

through the conduct of monetary policy
Money Supply
• Central banks are responsible to cond u cting m onetary

policy
• In som e cou ntries, the central bank is ind ep end ent of the
central governm ent to cond u ct m onetary policy
• Recall that m onetary policy refers to changes in a
cou ntry's stock of m oney su pply that seeks to stabilize
the level of econom ic activity and price level
• In m ost ad vanced cou ntries, stable prices m eans
inflation rate very close to 2% and ou tpu t as close as
possible to the fu ll em ploym ent level of ou tpu t

Topic Two
TOOLS OF MONETARY POLICY- OPEN

MARKET OPERATIONS

Open Market Operations
• Open market operations (OMO) refer to the purchase
or sale of government securities in the open market
• The open market here refers to dealers in government

bonds and individuals government securities are
government bonds/treasury bills
• Open market purchases (sales) are meant to increase

(reduce) the money supply

• To see how OMO affects the money supply, consider open market
purchase of government securities worth GHC 100m
• The central banks issues the initial a check worth GHC 100m which
can be drawn as cash or deposited into an account with a
commercial bank
• If the check is deposited in an account, the commercial bank can

creating additional loans out of it, increasing the money supply
further
• An open market sale will have the opposite effect on the money
supply

• In Ghana the Bank of Ghana's Monetary Policy Committee
announces the direction of monetary policy after its monthly
meeting
• In general the policy is announced as a target policy interest rate
• It is the rate at which the banks borrow from each other
• In Ghana, it is the monetary policy rate whereas in the US, it is

the federal funds rate (iff).
• Open market activities are then carried out to meet the target
policy rate .

Figure 2 Response to an Open Market Operation
Slide 13
Dr. Edward Asiedu
Topic Three
TOOLS OF MONETARY POLICY- THE

DISCOUNT RATE

Discount Rate
• Commercials banks can borrow from central banks

when they are short of reserves
• The interest rate charged on commercial banks

borrowing from the central bank is the discount rate
(id).
• Central banks raise (lower) the discount rate to signal

tightening (loosening) of monetary policy

Discount Rate
The Market For Reserves
• To derive the demand curve for reserves, we need to ask what

happens to the quantity of reserves demanded, holding everything
else constant, as the
• Policy rate changes.
• The amount of reserves can be split up into two components:

 (1) required reserves, which equal the required reserve ratio times
the amount of deposits on which reserves are required, and
• (2) excess reserves, the additional reserves banks choose to hold.
• Therefore, the quantity of reserves demanded equals required

reserves plus the quantity of excess reserves demanded.
Discount Rate
The Market For Reserves and the Discount Rate
• Demand and Supply in the Market for Reserves
• What happens to the quantity of reserves demanded by banks,

holding everything else constant, as the federal funds rate
changes?
• Excess reserves are insurance against deposit outflows
• The cost of holding these is the interest rate that could have
been earned minus the interest rate that is paid on these
reserves, ier
Discount Rate
Demand in the Market for Reserves
• When the policy rate is above the rate paid on excess

reserves, ier, as the policy rate decreases, the
opportunity cost of holding excess reserves falls and
the quantity of reserves demanded rises.
• Downward sloping demand curve that becomes flat

(infinitely elastic) at ier

Discount Rate
Supply in the Market for Reserves
• The supply of reserves, Rs, can be broken up into
two components:
 (1) the amount of reserves that are supplied by the

Central Bank’s open market operations, called non-
borrowed reserves (Rn), and
 (2) the amount of reserves borrowed from the
Central Bank, called discount loans (DL).

Discount Rate
Supply in the Market for Reserves
• Cost of borrowing from the Central Bank is the discount rate
• Borrowing from the Central Bank is a substitute for
borrowing from other banks
• If iff < id, then banks will not borrow from the Fed and
borrowed reserves are zero
• The supply curve will be vertical
• As iff rises above id, banks will borrow more and more at id,
and re-lend at iff
• The supply curve is horizontal (perfectly elastic) at id

Discount Rate
Figure 1 Equilibrium in the Market for Reserves

Topic Four
TOOLS OF MONETARY POLICY- THE

RESERVE REQUIREMENTS

Reserve Requirements
• For the purposes of prudence commercial banks keep a small

fraction of their deposits as cash or its close equivalent to pay
depositors who desire to withdraw
• The required reserve ratio is the fraction of deposits required

by banks to keep as reserves
• Banks may in addition to the required reserves, keep additional

excess reserves
• An increase in the required reserve ratio signals a tightening of

monetary policy
• The current Reserve Requirement in Ghana is 11%
Reserve Requirements
Disadvantages of Reserve Requirements
• No longer binding for most banks
• Can cause liquidity problems
• Increases uncertainty for banks

2017/2018
Session Overview
By the end of this session students should be able to:
• Illustrate the market for reserves and demonstrate

how changes in monetary policy can affect the policy
rate.
• Assess the relationship between money growth and
inflation in the short run and the long run, as implied
by the quantity theory of money.
• Identify the circumstances under which budget
deficits can lead to inflationary monetary policy.

Session Outline
The key topic to be covered in the session is the demand
for money:
More specifically:
• How Changes in the Tools of Monetary Policy Affect
the Policy Rate
• Quantity theory of money
• Inflation

Reading List

2010

Topic One
HOW CHANGES IN THE TOOLS OF

MONETARY POLICY AFFECT THE POLICY RATE

How Changes in the Tools of Monetary Policy
Affect the Policy Rate
• Effects of open an market operation depends on whether

the supply curve initially intersects the demand curve in
its downward sloped section versus its flat section.
• An open market purchase causes the policy rate to fall

whereas an open market sale causes the policy to rise
(when intersection occurs at the downward sloped
section).
• Open market operations have no effect on the policy rate
when intersection occurs at the flat section of the
demand curve.

How Changes in the Tools of Monetary
Policy Affect the Policy Rate
• If the intersection of supply and demand occurs on

the vertical section of the supply curve, a change in
the discount rate will have no effect on the policy
rate.
• If the intersection of supply and demand occurs on
the horizontal section of the supply curve, a change
in the discount rate shifts that portion of the supply
curve and the policy rate may either rise or fall
depending on the change in the discount rate
Figure 3 Response to a Change in the Discount Rate

• When the Central Bank raises reserve requirement,

the policy rate rises and when the Central Bank
decreases reserve requirement, the policy rate falls.

Figure 4 Response to a Change in Required Reserves

Topic Two
QUANTITY THEORY OF MONEY

Quantity theory of money
Velocity of Money and The Equation of Exchange:
M = the money supply
P = price level
Y = aggregate output (income)
P ´ Y = aggregate nominal income (nominal GDP)
V = velocity of money (average number of times per year that a dollar is spent)
P´Y
V=
M
Equation of Exchange
M ´V = P ´ Y
• Velocity fairly constant in short run
• Aggregate output at full-employment level
• Changes in money supply affect only the price level
• Movement in the price level results solely from change in

the quantity of money

• Demand for money: To interpret Fisher’s quantity theory in

terms of the demand for money…
• Divide both sides by V
1 1
M   PY k
V V
When the money market is in equilibrium

• M = Md
Let M d  k  PY
• Because k is constant, the level of transactions generated by a fixed
level of PY determines the quantity of Md.
• The demand for money is not affected by interest rates.

• From the equation of exchange to the quantity theory of
money:
 Fisher’s view that velocity is fairly constant in the short
run, so that , transforms the equation of exchange into the
quantity theory of money, which states that nominal
income (spending) is determined solely by movements in
the quantity of money M.
P  Y  M V

• Because the classical economists (including Fisher)
thought that wages and prices were completely
flexible, they believed that the level of aggregate
output Y produced in the economy during normal
times would remain at the full-employment level .
 Dividing both sides by Y , we can then write the
price level as follows:
M V
P
Y

Quantity theory of money and Inflation
• Percentage Change in (x ✕ y) = (Percentage Change in x) +
(Percentage change in y)
• Using this mathematical fact, we can rewrite the equation of

exchange as follows:
%M  %V  %P  %Y
• Subtracting from both sides of the preceding equation, and

recognizing that the inflation rate, is the growth rate of the
price level,   %P  %M  %V  %Y
• Since we assume velocity is constant, its growth rate is zero, so

the quantity theory of money is also a theory of inflation:
Dr. Edward Asiedu
  %M  %Y Slide 17
Topic Three
INFLATION

Inflation
Figure 1 Relationship Between Inflation and Money Growth
Sources: For panel (a), Milton Friedman and Anna Schwartz, Monetary Trends in the United States and the United Kingdom: Their
Relation to Income, Prices, and Interest Rates, 1867–1975; Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed
.org/fred2/. For panel (b), International Financial Statistics. International Monetary Fund, http://www.imfstatistics.org/imf/.
Slide 19
Dr. Edward Asiedu
Inflation
Figure 2 Annual U.S. Inflation and Money Growth Rates, 1965–2015
Sources: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2/.

Slide 20
Dr. Edward Asiedu
Inflation
Budget Deficits and Inflation
• There are two ways the government can pay for

spending: raise revenue or borrow
 Raise revenue by levying taxes or go into debt by

issuing government bonds
 The government can also create money and use it

to pay for the goods and services it buys
Slide 21
Dr. Edward Asiedu
Inflation
Budget Deficits and Inflation
• The government budget constraint thus reveals two
important facts:
 If the government deficit is financed by an increase in

bond holdings by the public, there is no effect on the
monetary base and hence on the money supply.
 But, if the deficit is not financed by increased bond

holdings by the public, the monetary base and the
money supply increase.
Slide 22
Dr. Edward Asiedu
Inflation
Hyperinflation
• Hyperinflations are periods of extremely high inflation of

more than 50% per month.
• Many economies—both poor and developed—have

experienced hyperinflation over the last century, but the
United States has been spared such turmoil.
• One of the most extreme examples of hyperinflation

throughout world history occurred recently in Zimbabwe in
the 2000s.
Slide 23
Dr. Edward Asiedu
2017/2018
Session Overview
• By the end of this session students should be able to:
• Summarize the three motives underlying the liquidity

preference theory of money demand.
• Identify the factors underlying the portfolio choice
theory of money demand.
• Assess and interpret the empirical evidence on the
validity of the liquidity preference and portfolio
theories of money demand

Session Overview
• Summarize the three motives underlying the liquidity

preference theory of money demand.
• Identify the factors underlying the portfolio choice
theory of money demand.
• Assess and interpret the empirical evidence on the
validity of the liquidity preference and portfolio
theories of money demand

Session Outline
The key topic to be covered in the session is the motives
for holding money
More specifically:
• The Transaction Motive.
• The Precautionary Motive.
• The Speculative Motive.
• Other determinants of money demand

Reading List

2010

Topic One
DEMAND FOR MONEY

Demand for Money
• Recall the demand for money is made of transactions
demand and asset demand
• The major determinants of demand for money are real

interest rate, level of income and expected inflation rate
• The quantity of money demanded falls when the interest

rate rises
• When interest rate rises, there is a higher incentive to

allocate more wealth to other interest-bearing assets and
reduce the holding of money balances

Demand for Money
Keynesian Theories of Money Demand
• Keynes’s liquidity preference theory
• Why do individuals hold money? Three motives:
 Transactions motive
 Precautionary motive
 Speculative motive
• Distinguishes between real and nominal quantities of

money
Demand for Money
Transactions Motive
• Keynes initially accepted the quantity theory view
that the transactions component is proportional to
income.
• Later, he and other economists recognized that new

methods for payment, referred to as payment
technology, could also affect the demand for money.

Demand for Money
Precautionary Motive
• Keynes also recognized that people hold money as

a cushion against unexpected wants.
• Keynes argued that the precautionary money

balances people want to hold would also be
proportional to income.

Demand for Money
Speculative Motive
• Keynes also believed people choose to hold money

as a store of wealth, which he called the speculative
motive

Demand for Money
Putting the Three Motives Together
Md
= f (i,Y ) where the demand for real money balances is
P
negatively related to the interest rate i,
and positively related to real income Y
Rewriting
P 1
d
=
M f (i,Y )
Multiply both sides by Y and replacing M d with M
PY Y
V = =
M f (i,Y )
Demand for Money
Putting the Three Motives Together
• Velocity is not constant:
 The procyclical movement of interest rates

should induce procyclical movements in
velocity.
 Velocity will change as expectations about

future normal levels of interest rates change
Demand for Money
Portfolio Theories of Money Demand
• Theory of portfolio choice and Keynesian
liquidity preference
 The theory of portfolio choice can justify the

conclusion from the Keynesian liquidity
preference function that the demand for real
money balances is positively related to income
and negatively related to the nominal interest
rate.
Demand for Money
Portfolio Theories of Money Demand
• Other factors that affect the demand for money:

– Wealth
– Risk
– Liquidity of other assets

Demand for Money
Summary Table 1 Factors That Determine the Demand for Money

Demand for Money
Empirical Evidence on the Demand for Money
• Precautionary demand:
– Similar to transactions demand

– As interest rates rise, the opportunity cost of
holding precautionary balances rises
– The precautionary demand for money is
negatively related to interest rates
Demand for Money
Interest Rates and Money Demand
• We have established that if interest rates do not
affect the demand for money, velocity is more likely
to be constant—or at least predictable—so that the
quantity theory view that aggregate spending is
determined by the quantity of money is more likely
to be true.
• However, the more sensitive the demand for

money is to interest rates, the more unpredictable
velocity will be, and the less clear the link between
the money supply and aggregate spending will be.
Demand for Money
Stability of Money Demand
• If the money demand function is unstable and

undergoes substantial, unpredictable shifts as
Keynes believed, then velocity is unpredictable,
and the quantity of money may not be tightly linked
to aggregate spending, as it is in the quantity
theory.
• The stability of the money demand function is also

crucial to whether the Bank of Ghana(BOG) should
target interest rates or the money supply.
Demand for Money
Stability of Money Demand
• If the money demand function is unstable
and so the money supply is not closely
linked to aggregate spending, then the
level of interest rates the BOG sets will
provide more information about the stance
of monetary policy than will the money
supply.
2017/2018
Session Overview
• List and describe the “three players” that influence

the money supply.
• Classify the factors affecting the Central Bank’s
assets and liabilities.
• Explain and illustrate the deposit creation process
using T-accounts.

Session Overview
• List the factors that affect the money supply.

• Summarize how the “three players” can influence the
money supply.
• Explain how the money creation process.

Session Outline
The key topic to be covered in the session is the money
supply process:
More specifically:
• The bank’s balance sheet.
• Control of the monetary base.
• Multiple Deposit Creation.

Reading List

2010

Topic one
THE MONEY SUPPLY PROCESS

Three Players in the Money Supply Process
1. The Central bank: Bank of Ghana

2. Banks: depository institutions; financial
intermediaries
3. Depositors: individuals and institutions

The BOG’s Balance Sheet
• Liabilities
– Currency in circulation: in the hands of the public
– Reserves: bank deposits at the BOG and vault cash
• Assets
– Government securities: holdings by the BOG that affect money
supply and earn interest
– Discount loans: provide reserves to banks and earn the discount
rate
• Control of the Monetary Base
High-powered money
MB = C + R
C = currency in circulation
R = total reserves in the banking system

Open Market Purchase from a Bank
• Net result is that reserves have increased by Ghc100

• No change in currency
• Monetary base has risen by Ghc100
Open Market Purchase from the Nonbank Public
• Person selling bonds to the Fed deposits the BOG’s check in the
bank
• Identical result as the purchase from a bank

Open Market Purchase from the Nonbank Public
• The person selling the bonds cashes the BOG’s check

• Reserves are unchanged
• Currency in circulation increases by the amount of the open market
purchase
• Monetary base increases by the amount of the open market purchase
Open Market Purchase: Summary
• The effect of an open market purchase on reserves

depends on whether the seller of the bonds keeps the
proceeds from the sale in currency or in deposits.
• The effect of an open market purchase on the monetary

base always increases the monetary base by the amount
of the purchase.
Open Market Sale
• Reduces the monetary base by the amount of the sale

• Reserves remain unchanged
• The effect of open market operations on the monetary base is
much more certain than the effect on reserves.
Shifts from Deposits into Currency
• Net effect on monetary liabilities is zero

• Reserves are changed by random fluctuations
• Monetary base is a relatively stable variable
Loans to Financial Institutions
• Monetary liabilities of the BoG have increased by Ghc100

• Monetary base also increases by this amount

Other Factors that Affect the Monetary Base
• Float
• Treasury deposits at the Bank of Ghana
• Interventions in the foreign exchange market

Overview of The BoG’s Ability to Control the Monetary
Base
• Open market operations are controlled by the BoG.

• The BoG cannot determine the amount of borrowing by
banks from the BoG.
• Split the monetary base into two components:
MBn= MB - BR
• The money supply is positively related to both the non-
borrowed monetary base MBn and
to the level of borrowed reserves, BR, from
the BoG.
Multiple Deposit Creation: A Simple Model
• Deposit Creation: Single Bank
• Excess reserves increase

• Bank loans out the excess reserves
• Creates a checking account
• Borrower makes purchases
• The Money supply has increased
Multiple Deposit Creation: A Simple Model
• Deposit Creation: The Banking System

Table 1 Creation of Deposits (assuming 10% reserve requirement and a $100 increase in reserves)

Critique of the Simple Model
• Holding cash stops the process
– Currency has no multiple deposit expansion
• Banks may not use all of their excess reserves to
buy securities or make loans.
• Depositors’ decisions (how much currency to
hold) and bank’s decisions (amount of excess
reserves to hold) also cause the money supply to
change.
Factors that Determine the Money Supply
• Changes in the nonborrowed monetary base MBn

– The money supply is positively related to the
non-borrowed monetary base MBn
• Changes in borrowed reserves from the Fed
– The money supply is positively related to the
level of borrowed reserves, BR, from the Fed

Factors that Determine the Money Supply
• Changes in the required reserves ratio

– The money supply is negatively related to the required
reserve ratio.
• Changes in currency holdings
– The money supply is negatively related to currency
holdings.
• Changes in excess reserves
– The money supply is negatively related to the amount of
excess reserves.
Overview of the Money Supply Process

2017/2018
Session Overview
• Derive and explain the multiplier.

• Distinguish between real and nominal interest rate
• Identify and explain three factors explaining the risk
structure of interest rates.

Session Outline
The key topic to be covered in the session is the multiplier
and the term structure of interest rate
More specifically:
• Deriving the multiplier.
• The risk structure of interest rate

Reading List

2010

Topic one
THE MULTIPLIER

Deriving The Formula for Multiple Deposit Creation
Assuming banks do not hold excess reserves
Required Reserves (RR ) = Total Reserves (R )
RR = Required Reserve Ratio (r ) times the total amount
of checkable deposits (D )
Substituting
r  D =R
Dividing both sides by r
1
 R
D =
r
Taking the change in both sides yields
1
D =  R
r
The Money Multiplier
• Define money as currency plus checkable deposits: M1

• Link the money supply (M) to the monetary base (MB) and let
m be the money multiplier
M  m  MB

Deriving the Money Multiplier
• Assume that the desired holdings of currency C and excess

reserves ER grow proportionally with checkable deposits D.
• Then,
c = {C/D} = currency ratio
e = {ER/D} = excess reserves ratio

The total amount of reserves (R) equals the sum of
required reserves (RR ) and excess reserves (ER ).
R = RR + ER
The total amount of required reserves equals the required
reserve ratio times the amount of checkable deposits
RR = r × D
Subsituting for RR in the first equation
R = (r × D) + ER
The Fed sets r to less than 1
• The monetary base MB equals currency (C) plus reserves (R):

MB = C + R = C + (r x D) + ER
• Equation reveals the amount of the monetary base needed to
support the existing amounts of checkable deposits, currency
and excess reserves.

c = {C / D}  C = c  D and
e = {ER / D}  ER = e  D
Substituting in the previous equation
MB  (r  D)  (e  D)  (c  D)  (r  e  c)  D
Divide both sides by the term in parentheses
1
D   MB
r ec
M  D  C and C  c  D
M  D  (c  D)  (1  c)  D
Substituting again
1 c
M   MB
r ec
The money multiplier is then
1 c
m Slide 11
r ec
Dr. Edward Asiedu
Intuition Behind the Money Multiplier
r  required reserve ratio = 0.10
C  currency in circulation = $400B
D  checkable deposits = $800B
ER  excess reserves = $0.8B
M  money supply (M1) = C  D = $1,200B
$400 B
c   0.5
$800 B
$0.8 B
e  0.001
$800 B
1  0.5 1.5
m   2.5
0.1  0.001  0.5 0.601
This is less than the simple deposit multiplier
Although there is multiple expansion of deposits,
there is no such expansion for currency
Quantitative Easing and the Money Supply, 2007-2014
• The global financial crisis began in the fall of 2007, led to the
initiation lending programs and large-scale asset-purchase
programs by central banks in an attempt to bolster the economy
• These lending and asset-purchase programs resulted in a huge

expansion of the monetary base and have been given the name
“quantitative easing.”
• This increase in the monetary base did not lead to an equivalent

change in the money supply because excess reserves rose
dramatically.

Figure 1 M1 and the Monetary Base, 2007-2014
Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2/.

Figure 2 Excess Reserves Ratio and Currency Ratio, 2007-2014
Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2/.

Topic Two
RISK STRUCTURE OF INTEREST RATES

Risk Structure of Interest Rates
• Bonds with the same maturity have
different interest rates due to:
–Default risk
–Liquidity
–Tax considerations
Figure 1 Long-Term Bond Yields, 1919–2014
Sources: Board of Governors of the Federal Reserve System, Banking and Monetary Statistics,1941–1970;
Federal Reserve Bank of St. Louis FRED database: http://research.stlouisfed.org/fred2

• Default risk: probability that the issuer of the bond
is unable or unwilling to make interest payments or
pay off the face value
– U.S. Treasury bonds are considered default free
(government can raise taxes).
– Risk premium: the spread between the interest
rates on bonds with default risk and the interest
rates on (same maturity) Treasury bonds
The Risk Structure of Interest
Rates
Price of Bonds, P Price of Bonds, P
T
S
Figure 2 Response to an Increase in Default Risk on Corporate Bonds
Sc T
i2 T
P2
Risk T
P c1 P1
Premium
c
P2
c
i2 D2T
T
c c D1
D2 D1
Quantity of Corporate Bonds Quantity of Treasury Bonds

(a) Corporate bond market (b) Default-free (U.S. Treasury) bond market
Step 1. An increase in default risk shifts the demand curve for corporate bonds left . . .
Step 2. and shifts the demand curve for Treasury bonds to the right . . .
Step 3. which raises the price of Treasury bonds and lowers the price of corporate
bonds, and therefore lowers the interest rate on Treasury bonds and raises the rate on
corporate bonds, thereby increasing the spread between the interest rates on corporate
versus Treasury bonds.
Table 1 Bond Ratings
by Moody’s, Standard
and Poor’s, and Fitch

• Liquidity: the relative ease with which an asset
can be converted into cash
– Cost of selling a bond
– Number of buyers/sellers in a bond market
• Income tax considerations
– Interest payments on municipal bonds are
exempt from federal income taxes.
Figure 3 Interest Rates on Municipal and Treasury Bonds
Price of Bonds, P Price of Bonds, P
ST
Sm
P m2
P 1m P1T
P 2T
D m2
D m1
D1T
D2T
Quantity of Municipal Bonds Quantity of Treasury Bonds

(a) Market for municipal (b)
Market for Treasury
bonds bonds
Step 1. Tax-free status shifts the demand for municipal bonds to the right . . .
Step 2. and shifts the demand for Treasury bonds to the left . . .
Step 3. with the result that municipal bonds end up with a higher price and a
lower interest rate than on Treasury bonds.
2017/2018
Session Overview
• Identify term structure of interest rates.

• List and explain the three theories of why interest
rates vary across maturities

Session Outline
The key topic to be covered in the session is Term
Structure of Interest Rates:
More specifically:.
• Term Structure of Interest Rates
• Expectations Theory.
• Segmented Markets Theory.
• Liquidity Premium & Preferred Habitat Theories

Reading List

2010

Topic One
TERM STRUCTURE OF INTEREST RATES

Term Structure of Interest Rates
• Bonds with identical risk, liquidity, and tax

characteristics may have different interest rates
because the time remaining to maturity is
different

• Yield curve: a plot of the yield on bonds with differing
terms to maturity but the same risk, liquidity and tax
considerations
– Upward-sloping: long-term rates are above
short-term rates
– Flat: short- and long-term rates are the same
– Inverted: long-term rates are below short-term rates

The theory of the term structure of interest rates must
explain the following facts:
1. Interest rates on bonds of different maturities
move together over time.
2. When short-term interest rates are low, yield
curves are more likely to have an upward slope;
when short-term rates are high, yield curves are
more likely to slope downward and be inverted.
3. Yield curves almost always slope upward.
Three theories to explain the three facts:
1. Expectations theory explains the first two facts but
not the third.
2. Segmented markets theory explains the third fact
but not the first two.
3. Liquidity premium theory combines the two
theories to explain all three facts.

Figure 4 Movements over Time of Interest Rates on U.S. Government Bonds with Different Maturities
Sources: Federal Reserve Bank of St. Louis FRED database: http://research.stlouisfed.org/fred2/

Topic Two
EXPECTATIONS THEORY

Expectations Theory
• The interest rate on a long-term bond will equal an
average of the short-term interest rates that people expect
to occur over the life of the long-term bond.
• Buyers of bonds do not prefer bonds of one maturity over
another; they will not hold
any quantity of a bond if its expected return
is less than that of another bond with a different maturity.
• Bond holders consider bonds with different maturities to
be perfect substitutes.
Expectations Theory
An example:
• Let the current rate on one-year bond be 6%.
• You expect the interest rate on a one-year bond
to be 8% next year.
• Then the expected return for buying two one-
year bonds averages (6% + 8%)/2 = 7%.
• The interest rate on a two-year bond must be
7% for you to be willing to purchase it.
Expectations Theory
For an investment of $1
it = today's interest rate on a one-period bond
e
i = interest rate on a one-period bond expected for next period
t 1
i2t = today's interest rate on the two-period bond

Expectations Theory
Expected return over the two periods from investing $1 in the
two-period bond and holding it for the two periods
(1 + i2t )(1 + i2t )  1
 1  2i2t  (i2t )2  1
 2i2t  (i2t ) 2
Since (i2t )2 is very small

the expected return for holding the two-period bond for two periods is
2i2t
Expectations Theory
If two one-period bonds are bought with the $1 investment
(1  it )(1  ite1 )  1
1  it  ite1  it (ite1 )  1
it  ite1  it (ite1 )
it (ite1 ) is extremely small
Simplifying we get
it  ite1
Expectations Theory
Both bonds will be held only if the expected returns are equal
2i2t  it  ite1
it  ite1
i2t 
2
The two-period rate must equal the average of the two one-period rates
For bonds with longer maturities
it  ite1  ite 2  ...  ite ( n 1)
int 
n
The n-period interest rate equals the average of the one-period
interest rates expected to occur over the n-period life of the bond
Expectations Theory
• Expectations theory explains:
– Why the term structure of interest rates changes at
different times.
– Why interest rates on bonds with different maturities
move together over time (fact 1).
– Why yield curves tend to slope up when short-term
rates are low and slope down when short-term rates are
high (fact 2).
• Cannot explain why yield curves usually slope upward
(fact 3)
Topic Three
SEGMENTED MARKETS THEORY

Segmented Markets Theory
• Bonds of different maturities are not substitutes at all.
• The interest rate for each bond with a different
maturity is determined by the demand for and supply
of that bond.
• Investors have preferences for bonds of one maturity
over another.
• If investors generally prefer bonds with shorter
maturities that have less interest-rate risk, then this
explains why yield curves usually slope upward (fact
3).
Topic Four
LIQUIDITY PREMIUM & PREFERRED

HABITAT THEORIES

Liquidity Premium & Preferred Habitat Theories
• The interest rate on a long-term bond will equal an
average of short-term interest rates expected to occur
over the life of the long-term bond plus a liquidity
premium that responds to supply and demand
conditions for that bond.
• Bonds of different maturities are partial (not perfect)
substitutes.

Liquidity Premium Theory
it  it1
e
 it2
e
 ... it(n1)
e
int   lnt
n
where lnt is the liquidity premium for the n-period bond at time t
lnt is always positive
Rises with the term to maturity

Preferred Habitat Theory
• Investors have a preference for bonds of one maturity
over another.
• They will be willing to buy bonds of different
maturities only if they earn a somewhat higher
expected return.
• Investors are likely to prefer short-term bonds over
longer-term bonds.

Figure 5 The Relationship Between the Liquidity Premium (Preferred Habitat) and Expectations
Interest Theory
Liquidity Premium (Preferred Habitat)
Rate, int Theory
Yield Curve
Liquidity
Premium, lnt
Expectations Theory
Yield Curve
0 5 10 15 20 25 30
Years to Maturity, n

Liquidity Premium & Preferred Habitat Theories
• Interest rates on different maturity bonds move together over
time; explained by the first term in
the equation
• Yield curves tend to slope upward when short-term rates are
low and to be inverted when short-term rates are high;
explained by the liquidity premium term in the first case and
by a low expected average in the second case
• Yield curves typically slope upward; explained
by a larger liquidity premium as the term to
maturity lengthens

Yield to Yield to
Maturity Maturity
Steeply upward- Mildly upward-

sloping yield sloping yield
Figure 6 Yield curve curve
Curves and the
Term to Maturity Term to Maturity
Market’s (a) (b)
Expectations of
Future Short- Yield to Yield to
Maturity Maturity
Term Interest
Rates According
to the Liquidity
Premium Flat yield curve Downward-
(Preferred sloping yield curve
Habitat) Theory Term to Maturity Term to Maturity

(c) (d)

Figure 7 Yield Curves for U.S. Government Bonds

2017/2018
Session Overview
• Explain aggregate demand aggregate supply

• Summarize and illustrate the aggregate demand curve
• Illustrate and interpret the short-run and long-run
aggregate supply curves.
• Explain the factors that shift the aggregate demand
and aggregate supply curve

Session Outline
The key topics to be covered in the session are :
• Aggregate Demand
• Aggregate Supply
• Factors that affect aggregate demand and aggregate
supply

Reading List

2010

Topic One
AGGREGATE DEMAND

Aggregate Demand
• Aggregate demand is made up of four component parts:
– consumption expenditure: the total demand for consumer
goods and services
– planned investment spending: the total planned spending
by business firms on new machines, factories, and other
capital goods, plus planned spending on new homes
– government purchases: spending by all levels of
government (federal, state, and local) on goods and
services
– net exports: the net foreign spending on domestic goods
and services
Aggregate Demand
Y ad  C  I  G  NX
The aggregate demand curve is downward sloping because
P  M / P  i  I  Y ad 
and
P  M / P  i  E  NX  Y ad 

Aggregate Demand
• The fact that the aggregate demand curve is

downward sloping can also be derived from the
quantity theory of money analysis.
• If velocity stays constant, a constant money supply
implies constant nominal aggregate spending, and a
decrease in the price level is matched with an increase
in aggregate demand.

Aggregate Demand
Inflation
Rate, π
Figure 1 Leftward Shift in the Aggregate Demand Curve
r , G , T , NX , C , I , f 
decreases aggregate demand
and shifts the AD curve to the
left
AD2 AD1
Aggregate Output, Y

Aggregate Demand
Figure 2 Rightward Shift in the Aggregate Demand Curve
Inflation
Rate, π
r  ,G  , T  , NX  , C , I  , f 
Increases aggregate
demand and shifts the AD
curve to the right
AD2
AD1
Affregate Output, Y

Aggregate Demand
Factors that Shift the Aggregate Demand Curve
• An increase in the money supply

shifts AD to the right: holding velocity constant, an
increase in the money supply increases the quantity of
aggregate demand at each price level.
• An increase in spending from any of
the components C, I, G, NX, will also shift AD to the
right.
Aggregate Demand
Summary Table 1
Factors That
Shift the
Aggregate
Demand Curve

Topic Two
AGGREGATE SUPPLY

Aggregate Supply
• Long-run aggregate supply curve:

• Determined by amount of capital and labor and the available
technology
• Vertical at the natural rate of output generated by the natural
rate of unemployment
• Short-run aggregate supply curve:
• Wages and prices are sticky
• Generates an upward sloping SRAS as firms attempt to take
advantage of short-run profitability when price level rises
Aggregate Supply
• Figure 3 Long- and Short-Run Aggregate Supply Curves

Aggregate Supply
Shifts in Aggregate Supply Curves
• Shifts in the long run aggregate supply curve
• The long-run aggregate supply curve shifts to the right from when
there is:
• An increase in the total amount of capital in the economy
• An increase in the total amount of labor supplied in the economy
• An increase in the available technology, or
• A decline in the natural rate of unemployment
• An opposite movement in these variables shifts the LRAS curve to
the left.
Aggregate Supply
• Figure 4 Shift in the Long-Run Aggregate Supply Curve

Aggregate Supply
Shifts in the Short-Run Aggregate Supply Curve
• There are three factors that can shift the short-run

aggregate supply curve:
1. Expected inflation
2. Price shocks
3. A persistent output gap

Aggregate Supply
• Summary Table 2 Factors That Shift the Short-Run Aggregate Supply Curve

Aggregate Supply
Figure 5 Shift in the Short-Run Aggregate Supply Curve from Changes in Expected Inflation and
Price Shocks

Aggregate Supply
Figure 6 Shift in the Short-Run Aggregate Supply Curve from a Persistent Positive Output Gap

2017/2018
Session Overview

equilibria, and the role of the self-correcting
mechanism.
• Illustrate and interpret the short-run an long-run
effects of a shock to aggregate demand.
effects of temporary and permanent supply shocks.

Session Outline
• Aggregate Demand
• Aggregate Supply
• Equilibrium in Aggregate Demand and Supply Analysis

Reading List

2010

Topic One
EQUILIBRIUM IN AGGREGATE
DEMAND AND SUPPLY ANALYSIS

Equilibrium in Aggregate Demand and
Supply Analysis
• We can now put the aggregate demand and

supply curves together to describe general
equilibrium in the economy, when all
markets are simultaneously in equilibrium at
the point where the quantity of aggregate
output demanded equals the quantity of
aggregate output supplied.

Supply Analysis
Short-Run Equilibrium
• Figure 7 illustrates a short-run equilibrium in
which the quantity of aggregate output
demanded equals the quantity of output supplied.
• In Figure 8, the short-run aggregate demand
curve AD and the short-run aggregate supply
curve AS intersect at point E with an equilibrium
level of aggregate output at Y and an
*

equilibrium inflation rate at .
*

Supply Analysis
Figure 7 Short-Run Equilibrium

Supply Analysis
Figure 8 Adjustment to Long-Run Equilibrium in Aggregate Supply and Demand
Analysis

Supply Analysis
Self-Correcting Mechanism
• Regardless of where output is initially, it returns
eventually to the natural rate.
• Slow:
– Wages are inflexible, particularly downward
– Need for active government policy
• Rapid:
– Wages and prices are flexible
– Less need for government intervention
Supply Analysis
Changes in Equilibrium: Aggregate Demand Shocks
• With an understanding of the distinction between the

short-run and long-run equilibria, you are now ready to
analyze what happens when there are demand shocks,
shocks that cause the aggregate demand curve to shift.

Supply Analysis
Figure 9 Positive Demand Shock

Supply Analysis
Figure 10 The Volcker Disinflation
Source:
Economic
Report of the
President.
Supply Analysis
Figure 11 Negative Demand Shocks, 2000–2004
Source:
Economic
Report of the
President.
Supply Analysis
Changes in Equilibrium: Aggregate Supply (Price)
Shocks
• The aggregate supply curve can shift from temporary

supply (price) shocks in which the long-run aggregate
supply curve does not shift, or from permanent supply
shocks in which the long-run aggregate supply curve does
shift.
Slide 15
Dr. Edward Asiedu
Supply Analysis
Changes in Equilibrium: Aggregate Supply (Price) Shocks
• Temporary Supply Shocks:
– When the temporary shock involves a restriction in supply,
we refer to this type of supply shock as a negative (or
unfavorable) supply shock, and it results in a rise in
commodity prices.
– A temporary positive supply shock shifts the short-run
aggregate supply curve downward and to the right, leading
initially to a fall in inflation and a rise in output. In the long
run, however, output and inflation will be unchanged (holding
the aggregate demand curve constant).
Slide 16
Dr. Edward Asiedu
Supply Analysis
Figure 12 Temporary Negative Supply Shock

Supply Analysis
Figure 13 Negative Supply Shocks, 1973–1975 and 1978–1980
Source:
Economic
Report of the
President.
Slide 18
Dr. Edward Asiedu
Supply Analysis
Permanent Supply Shocks and Real Business Cycle
Theory
• A permanent negative supply shock—such as an increase
in ill-advised regulations that causes the economy to be
less efficient, thereby reducing supply—would decrease
potential output and shift the long-run aggregate supply
curve to the left.
• Because the permanent supply shock will result in higher
prices, there will be an immediate rise in inflation and so
the short-run aggregate supply curve will shift up and to
the left. Slide 19
Dr. Edward Asiedu
Supply Analysis
Permanent Supply Shocks and Real Business Cycle
Theory
• One group of economists, led by Edward Prescott of

Arizona State University, believe that business cycle
fluctuations result from permanent supply shocks alone
and their theory of aggregate economic fluctuations is
called real business cycle theory.
Slide 20
Dr. Edward Asiedu
Supply Analysis
Figure 14 Permanent Negative Supply Shock
Slide 21
Dr. Edward Asiedu
Supply Analysis
Figure 15 Positive Supply Shocks, 1995–1999
Source:
Economic
Report of the
President.
Slide 22
Dr. Edward Asiedu
Supply Analysis
Conclusions
• Aggregate demand and supply analysis yields the
following conclusions:
1. A shift in the aggregate demand curve affects output only in the short
run and has no effect in the long run.
2. A temporary supply shock affects output and inflation only in the
short run and has no effect in the long run (holding the aggregate
demand curve constant).
3. 3. A permanent supply shock affects output and inflation both in the
short and the long run.
4. 4. The economy has a self-correcting mechanism that returns it to
potential output and the natural rate of unemployment over time.
Slide 23
Dr. Edward Asiedu
Supply Analysis
The Phillips Curve and the Short-Run Aggregate Supply
Curve
• The Phillips Curve: the negative relationship between
unemployment and inflation.
• The idea behind the Phillips curve is intuitive: When labor
markets are tight—that is, the unemployment rate is
low—firms may have difficulty hiring qualified workers
and may even have a hard time keeping their present
employees. Because of the shortage of workers in the
labor market, firms will raise wages to attract needed
workers and raise their prices at a more rapid rate.
Slide 24
Dr. Edward Asiedu
Supply Analysis
Figure 2 The Short- and Long-Run Phillips Curve
Slide 25
Dr. Edward Asiedu
Supply Analysis
Three Important Conclusions
1. There is no long-run trade-off between unemployment

and inflation.
2. There is a short-run trade-off between unemployment
and inflation.
3. There are two types of Phillips curves, long run and short
run.
Slide 26
Dr. Edward Asiedu
Supply Analysis
The Short-Run Aggregate Supply Curve
• To complete our aggregate demand and supply model, we
need to use our analysis of the Phillips curve to derive a
short-run aggregate supply curve, which represents the
relationship between the total quantity of output that firms
are willing to produce and the inflation rate.
• We can translate the modern Phillips curve into a short-
run aggregate supply curve by replacing the
unemployment gap (U – Un) with the output gap, the
difference between output and potential output (Y – YP).
Slide 27
Dr. Edward Asiedu
Supply Analysis
Okun’s Law
• Okun’s law describes the negative relationship between
the unemployment gap and the output gap.
• Okun’s law states that for each percentage point that
output is above potential, the unemployment rate is one-
half of a percentage point below the natural rate of
unemployment. Alternatively, for every percentage point
that unemployment is above its natural rate, output is two
percentage points below potential output.
Slide 28
Dr. Edward Asiedu
Supply Analysis
• Figure Okun’s Law, 1960–2014
Slide 29
Dr. Edward Asiedu
2017/2018
Session Overview
• Illustrate and explain the policy choices that monetary

policymakers face under the conditions of aggregate
demand shocks, temporary supply shocks and permanent
supply shocks.
• Identify the lags in the policy process, and summarize
why they weaken the case for an activist policy approach.
• Explain why monetary policymakers can target any
inflation rate in the long-run but cannot target aggregate
output in the long-run.

Session Overview
• Identify the sources of inflation and the role of

monetary policy in propagating inflation.
• Explain the unique challenges that monetary
policymakers face at the zero lower bound, and
illustrate how nonconventional monetary policy can
be effective under such conditions.

Session Outline
• Response of Monetary Policy to Shocks
• Response to an Aggregate Demand and supply Shocks
• Lags and Policy Implementation
• Inflation
• Monetary Policy at the Zero Lower Bound
• Monetary Policy and Quantitative Easing
• Management of Expectations

Reading List

2010

Topic One
MONETARY POLICY THEORY

Response of Monetary Policy to Shocks
• Monetary policy should try to minimize the difference

between inflation and the inflation target.
• In the case of both demand shocks and permanent supply
shocks, policy makers can simultaneously pursue price
stability and stability in economic activity.
• Following a temporary supply shock, however, policy
makers can achieve either price stability or economic
activity stability, but not both. This tradeoff poses a
dilemma for central banks with dual mandates.
• Policy makers can respond to this shock in two possible

ways:
– No policy response
– Policy stabilizes economic activity and inflation in the short run
• In the case of aggregate demand shocks, there is no
tradeoff between the pursuit of price stability and
economic activity stability.

• Figure 1 Aggregate Demand Shock: No Policy Response

• Figure 2 Aggregate Demand Shock: Policy Stabilizes Output and Inflation in the Short Run

• Response to a Permanent Supply Shock
• There are two possible policy responses to a

permanent supply shock:
- No policy response
- Policy stabilizes inflation

• Figure 3 Permanent Supply Shock: No Policy Response

• Figure 4 Permanent Supply Shock: Policy Stabilizes Inflation

• Response to a Temporary Supply Shock
• When a supply shock is temporary, policymakers face
a short-run tradeoff between stabilizing inflation and
economic activity.
• Policymakers can respond to the temporary supply
shock in three possible ways:
– No policy response
– Policy stabilizes inflation in the short run
– Policy stabilizes economic activity in the short run

• Figure 5 Response to a Temporary Aggregate Supply Shock: No Policy Response

• Figure 6 Response to a Temporary Aggregate Supply Shock: Short-Run Inflation Stabilization

• Figure 7 Response to a Temporary Aggregate Supply Shock: Short-Run Output Stabilization

The Bottom Line: The Relationship Between Stabilizing Inflation
and Stabilizing Economic Activity
• We can draw the following conclusions from this
analysis:
1. If most shocks to the economy are aggregate demand shocks or
permanent aggregate supply shocks, then policy that stabilizes
inflation will also stabilize economic activity, even in the short run.
2. If temporary supply shocks are more common, then a central bank

must choose between the two stabilization objectives in the short run.
3. In the long run there is no conflict between stabilizing inflation and

economic activity in response to shocks.
How Actively Should Policy Makers Try to Stabilize Economic
Activity?
• All economists have similar policy goals (to promote high

employment and price stability), yet they often disagree
on the best approach to achieve those goals.
• Nonactivists believe government action is unnecessary to
eliminate unemployment.
• Activists see the need for the government to pursue active
policy to eliminate high unemployment when it develops.
Lags and Policy Implementation
• Several types of lags prevent policymakers from shifting

the aggregate demand curve instantaneously:
– Data lag: the time it takes for policy makers to obtain data
indicating what is happening in the economy
– Recognition lag: the time it takes for policy makers to be sure
of what the data are signaling about the future course of the
economy

Lags and Policy Implementation
• Several types of lags prevent policymakers from shifting
the aggregate demand curve instantaneously:
– Legislative lag: the time it takes to pass legislation to
implement a particular policy
– Implementation lag: the time it takes for policy makers to
change policy instruments once they have decided on the new
policy
– Effectiveness lag: the time it takes for the policy actually to
have an impact on the economy

Inflation: Always and Everywhere a Monetary
Phenomenon
• This adage is supported by our aggregate demand and

supply analysis because it shows that monetary policy
makers can target any inflation rate in the long run by
shifting the aggregate demand curve with autonomous
monetary policy.

• Figure 8 A Rise in the Inflation Target

Causes of Inflationary Monetary Policy
• High employment targets and inflation:

– Cost-push inflation results either from a temporary
negative supply shock or a push by workers for wage
hikes beyond what productivity gains can justify.
– Demand-pull inflation results from policy makers
pursuing policies that increase aggregate demand.

• Figure 9 Cost-Push Inflation

• Figure 10 Demand-Pull Inflation

• Figure 11 Inflation and Unemployment, 1965-1982

Monetary Policy at the Zero Lower Bound
• The Fed can attempt to reduce the real interest rate by

lowering the federal funds rate.
• The federal funds rate, though, is stated in nominal terms,
and therefore cannot fall below zero.
• The zero floor on the federal funds rate is referred to as
the zero lower bound.

Deriving the Aggregate Demand Curve with the
Zero Lower Bound
• The MP curve is normally upward sloping.

• With the federal funds rate at the floor of zero, as inflation
and expected inflation fall, the real interest rate rises,
creating a downward slope for the MP curve.
• The process described above creates a kink in the
Aggregate Demand curve as well.

• Figure 12 Derivation of the Aggregate Demand Curve with a Zero Bound

The Disappearance of the Self-Correcting Mechanism at
the Zero Lower Bound
• When the economy is in a situation in which equilibrium

output is below potential output and the zero lower bound
on the policy rate has been reached, output is not restored
to its potential level if policymakers do nothing.
• In addition, in this situation the economy goes into a
deflationary spiral, characterized by continually falling
inflation and output.
• Figure 13 The Absence of the Self-Correcting Mechanism at the Zero Lower Bound

Application Nonconventional Monetary Policy and
Quantitative Easing
• Sometimes the negative aggregate demand shock is so
large that at some point the central bank cannot lower the
real interest rate further because the nominal interest rate
hits a floor of zero, as occurred after the Lehman Brothers
bankruptcy in late 2008.
• In this situation when the zero-lower-bound problem
arises, the central bank must turn to nonconventional
monetary policy.

Application Nonconventional Monetary Policy and
Quantitative Easing
• Nonconventional monetary policy takes three forms:

1. Liquidity provision
2. Asset purchases (quantitative easing)
3. Management of expectations

• Figure 14 Response to a Rise in Inflation Expectations

Liquidity Provision
• A central bank can bring down financial frictions directly

by increasing its lending facilities in order to provide
more liquidity to impaired markets so that they can return
to their normal functions.
• This decline in financial frictions lowers the real interest
rate for investments.

Management of Expectations
• Forward guidance in which the central bank commits to

keeping the policy rate low for a long period of time is
another way of lowering long-term interest rates relative
to short-term rates and thereby lowering financial
frictions and the real interest rate for investments.
• This can lead to both rightward shifts in aggregate
demand and by shifting the short-run aggregate supply
curve by raising expectations of inflation.
• Figure 15 Response to a Rise in Inflation Expectations

2017/2018
Session Overview
• .Explain financial crisis and how is comes about

• Identify dynamics of financial crisis
• Identify and analyze the causes and effect of the great
depression
• Identify and analyze the causes and effect of the
2007-2009 global financial crisis.

Session Outline
• Financial crisis and it dynamics
• The Great Depression
• The 2007-2009 global financial crisis

Reading List

2010

Topic One
FINANCIAL CRISIS

• A financial crisis occurs when there is a particularly large

disruption to information flows in financial markets, with
the result that financial frictions increase sharply and
financial markets stop functioning.

Stage One: Initiation of a Financial Crisis
• Credit Boom and Bust: Mismanagement of financial
• liberalization/innovation leading to asset price boom and
bust
• Asset-price Boom and Bust
• Increase in Uncertainty
Stage two: Banking Crisis
Stage three: Debt Deflation

• How did a financial crisis unfold during the Great
Depression and how it led to the worst economic
downturn in U.S. history?
• This event was brought on by:
- Stock market crash
- Bank panics Continuing decline in stock prices
- Debt deflation

Topic Two
THE GLOBAL FINANCIAL CRISIS OF
2007-2009

• Causes of the 2007-2009 Financial Crisis:
*Financial innovations emerge in the mortgage
markets
-Subprime mortgage
-Mortgage-backed securities
-Collateralized debt obligations (CDOs)
• Housing price bubble forms
-Increase in liquidity from cash flows surging to the
United States
-Development of subprime mortgage market fueled
housing demand and housing prices
Causes of the 2007-2009 financial crisis
• Agency problems arise:
- Originate-to-distribute model is subject to principal-
(investor) agent (mortgage broker) problem
- Borrowers had little incentive to disclose information
about their ability to pay
-Commercial and investment banks (as well as rating
agencies) had weak incentives to assess the quality of
securities
• Information problems surface
• Housing price bubble bursts
• The creation of a collateralized debt obligation involves a
corporate entity called a special purpose vehicle (SPV)
that buys a collection of assets such as corporate bonds
and loans, commercial real estate bonds, and mortgage-
backed securities.
• The SPV separates the payment streams (cash flows)
from these assets into buckets that are referred to as
tranches.

• The highest rated tranches, referred to as super senior
tranches are the ones that are paid off first and so have
the least risk.
• The lowest tranche of the CDO is the equity tranche and
this is the first set of cash flows that are not paid out if
the underlying assets go into default and stop making
payments. This tranche has the highest risk and is often
not traded.

• After a sustained boom, housing prices began a long decline
beginning in 2006.
• The decline in housing prices contributed to a rise in defaults on
mortgages and a deterioration in the balance sheet of financial
institutions.
• This development in turn caused a run on the shadow banking
system.
• Crisis spreads globally
-Sign of the globalization of financial markets
-TED spread (3 months interest rate on Eurodollar minus 3 months
Treasury bills interest rate) increased from 40 basis points to almost
240 in August 2007
• Deterioration of financial institutions' balance sheets:
-Write downs
-Sell of assets and credit restriction
• High-profile firms fail
-Bear Stearns (March 2008)
-Fannie Mae and Freddie Mac (July 2008)
-Lehman Brothers, Merrill Lynch, AIG, Reserve Primary
Fund (mutual fund) and Washington Mutual (September
2008)
• Bailout package debated
-House of Representatives voted down the $700 billion
bailout package on September 29, 2008.
-It passed on October 3, 2008.
-Congress approved a $787 billion economic stimulus
plan on February 13, 2009.

• Some economists have argued that the low rate interest
policies of the Federal Reserve in the 20032006 period
caused the housing price bubble.
• Taylor argues that the low federal funds rate led to low
mortgage rates that stimulated housing demand and
encouraged the issuance of subprime mortgages, both of
which led to rising housing prices and a bubble.

• Federal Reserve Chairman Ben Bernanke countered this
argument, saying the culprits were the proliferation of
new mortgage products that lowered mortgage
payments, a relaxation of lending standards that brought
more buyers into the housing market, and capital inflows
from emerging market countries.
• The debate over whether monetary policy was to blame
for the housing price bubble continues to this day.

• The increase in budget deficits that followed the financial
• crash of 2007-2009 led to fears of government defaults
and a surge in interest rates.
• The sovereign debt, which began in Greece, moved on to
Ireland, Portugal, Spain and Italy.
• The stresses created by this and related events continue
to threaten the viability of the Euro.

Height of the 2007-2009 Financial Crisis
• The stock market crash gathered pace in the fall of 2008,
with the week beginning October 6, 2008, showing the
worst weekly decline in U.S. history.
• Surging interest rates faced by borrowers led to sharp
declines in consumer spending and investment.
• The unemployment rate shot up, going over the 10%
level in late 2009 in the midst of the Great Recession, the
worst economic contraction in the United States since
World War II.
Short-term Responses and Recovery
• Financial Bailouts: In order to save their financial sectors and to
avoid contagion, financial support was provided by many
governments to bail out banks, other financial institutions, and
even the so-called too-big-to-fail firms that were severely affected
by the financial crisis.
• Fiscal Stimulus Spending: To boost their individual economies,
most governments used fiscal stimulus packages that combined
government expenditure and tax cuts.
• Japan's consecutive stimulus packages, totaling $568 billion, were
among the highest during the crisis, but these proved largely
ineffective
•Dr. Edward
European
Asiedu nations showed moderate success.
Slide 27
• Latvia's independence from the USSR in 1991 and its fiscal policies
helped it join the EU, 2004; and the Eurozone, 2014.
• Latvia's economic policies had a low budget deficit and a fixed
exchange rate against the Euro.
• In 2007, the country's second-largest bank, Parex Bank, collapsed.
Latvia needed ¿7.5 billion to recapitalize and meet external
financing requirements.
• Austerity program: citizens voluntarily endured the layoff of 25% of
state workers, 40% salary cuts, and social expenditure reductions.
• After a contraction of over 25%, the country's GDP started to grow
to its near pre-crisis levels.
• Expansionary Contraction: Success in Latvia, but maybe
inapplicable
Dr. Edward Asiedu in other countries because of the political motivations
Slide 28
With the individual emergency national bailouts to rescue
national economies and financial sectors, global leaders
looked to building a more stable and robust global financial
system. Steps taken by governments included
• Implement sound macroeconomic policies
• Enhance their financial infrastructure
• Develop financial education and consumer protection
rules
• Enact macro and micro prudential regulations.

• At the international level
-Proactive globally-binding supervision was designed
-Financial market discipline enforced
-Systemic risk managed
• To avoid collective action problems and to ensure that
policy actions are mutually consistent with national
growth objectives, aggregate plans began to be drafted
simultaneously. The first ever of these is the Mutual
Assessment Process launched in 2009 by the G20.

Finc 402 Monetary Theory Ob Marvin

Uploaded by

Copyright:

Available Formats

Finc 402 Monetary Theory Ob Marvin

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Finc 402 Monetary Theory Ob Marvin

Uploaded by

Copyright:

Available Formats

Lecturer: Dr.

Edward Asiedu, UGBS

In this session, we will explore;

Dr. Edward Asiedu Slide 2

• Why should accountants and financial analysts be interested in

Dr. Edward Asiedu Slide 3

Dr. Edward Asiedu Slide 4

WHY SHOULD ACCOUNTANTS AND

Financial intermediaries: institutions that borrow funds from people

• Banks: institutions that accept deposits and make loans.

• And therefore it is important to understand how financial

• Also, importantly, to understand the role of money in the

• Money plays a key role in generating business Cycles (recessions

• Business Cycles are upward and downward movement of aggregate

• Business cycles affect all of us in immediate and important ways.

Dr. Edward Asiedu Slide 7

• Recession (unemployment) and economic booms affect all of

• Changes in the money supply impacts changes in aggregate

Dr. Edward Asiedu Slide 8

ROLE AND NATURE OF MONEY

Dr. Edward Asiedu Slide 9

• To understand the effects of money on the economy,

• We will explore the key functions of money, looking at

• As the word money is used in everyday conversation, it can mean

• Economists define money (also referred to as the money supply) as

• When most people talk about money, they’re talking about

Dr. Edward Asiedu Slide 11

• To define money merely as currency is much too narrow for

• Because cheques are also accepted as payment for purchases,

• An even broader definition of money is often needed,

Dr. Edward Asiedu Slide 12

• Thus while “currency” is too narrow a definition of

Dr. Edward Asiedu Slide 13

Dr. Edward Asiedu Slide 14

• Whether money is kola or shells or rocks or gold or

Dr. Edward Asiedu Slide 15

• The use of money as a medium of exchange promotes

Dr. Edward Asiedu Slide 16

• It is even possible that she will have to quit lecturing and go

Dr. Edward Asiedu Slide 17

• In a barter economy, transaction costs are high because

• The use of money as a medium of exchange there promotes

Dr. Edward Asiedu Slide 18

• It must be easily standardized, making it simple to ascertain its

Examples of money (in history): Tobacco, whiskey, cigarettes used in

Dr. Edward Asiedu Slide 19

• The second role of money is to provide a unit of account; that

• Just as we measure weight in terms of kilograms or distance in

• To see why this function is important, let’s look again at a

Dr. Edward Asiedu Slide 20

• The solution to the problem is to introduce money into the

Dr. Edward Asiedu Slide 21

• We can see that using money as a unit of account reduces

• The benefits of this function of money grow as the economy

Dr. Edward Asiedu Slide 22

• Money also functions as a store of value; it is a repository

• A store of value is used to save purchasing power from

• This function of money is useful, because most of us do

Dr. Edward Asiedu Slide 23

• Money is not unique as a store of value; any asset—whether