- A real money balance is the quantity of money expressed in real terms (MIP). If the nominal money supply and prices increase by the same percentage, then the demand for and supply of real money balances stays the same.
- If real income increases by 20% then demand for real money balances increases by les than 20%. The change in demand is not proportional to the change in real income.
- A one-time increase in prices increases prices only one time. Inflation is a sustained overall price increase as measured by a price index. A one-time increase in prices does not affect the demand for real money balances. Expected inflation reduces the demand for real balances.
- Firms want to hold real money balances to consummate transactions. In deciding the optimum amount of money balances to hold, a firm will want to minimize money holdings, subject to the constraint of having enough money on hand or access to it when its needed.
- If interest rates on time deposits rise relative to interest rates on checkable deposits, the demand for real balances will fall.
- There is an inverse relationship between the quantity demanded of real money balances and the interest rate, ceteris paribus.
- The conclusions of Chapter 3 support monetarism, which is the school of thought that emphasizes the importance of changes in the nominal money supply as a cause of fluctuations in prices, employment, and output.
- The caveat of the Keynesian liquidity preference theory is that if interest rates are high, more and more individuals will come to believe that rates will be going down in the future and will therefore prefer to buy bonds today in hopes of a capital gain when interest rates do fall. Consequently, because individuals hold either bonds or money, when interest rates are high, the quantity demanded of money will be low.
The liquidity trap is that when interest rates are very low (bond prices are high), the demand for money becomes perfectly horizontal, and the economy is in a liquidity trap; the Fed is unable to lower interest rates by increasing the supply of money.
- The market for real money balances is in equilibrium when the quantity supply of and the quantity demanded of real money balances are equal.
- The transaction motive is a motive for holding money based on the need to make payments. The precautionary motive is a motive for holding money as a precaution against unforeseen developments.
- The benefits of holing real money balances are the interest payments that are earned on checkable deposits plus the stream of services that money balances provide.
The cost of holding real money balances are the foregone interest payments that holding nonmonetary financial assets would have yielded.
Households and firms should adjust their holdings of real balances to the point where the marginal benefits of doing so are equal to the marginal costs.
- A. Since the demand for real balances decreases, the demand curve (D curve) shifts to the left causing
A lower interest rate.