Description
This is a presentation explaining about Demand for Money; Drivers of demand for money; Money Supply Process
Demand for Money – Why bother
? ? ? ? ? ?
Is the current money stock (M3) adequate for the current level of economic activity? How would we know whether it is less or more than what is required ? How fast or slow M3 needs to change given the expected change in economic activity? How fast or slow will output respond to a given a change M3 ? How long the effect will last? What if the response is too weak or in the unintended direction?
Demand for Money – Who bothers
The CB needs answers to such questions ? It thus needs a reliable estimate of demand for money, and ? Some target in relation to which the adequacy or otherwise of the current money stock can be made ? What should that target be – M0, M1 M3, Interest Rate, Inflation, GDP, Employment? ? If M3 is a target, what should be its level? ? To fix that level – say M3 growth of 15% some idea of money demand is essential ? This is not to say that M3 as a target is a must but only to say that if M3 is a target then money demand needs to be estimated
?
Drivers of demand for money
? ?
?
Why individuals and firms hold money? Relative importance of transaction motive (medium of exchange) and speculative motive (store of value) These in turn are influenced by (some illustrative factors) ? Degree of monetization ? Organization of production ? Payment systems – instruments, technology ? Interest rates - current and expected ? Inflation – current and expected
? Degree of vertical integration ? Income intensity of transactions
Demand for money – simple formulation
?
?
?
Income equation ? If Y = P*y (Y nominal income y real income) ? then M*V = P*y (where V is number of time money stock is used in income transactions – final goods and services – recall national income definition). ? V would then be income velocity of money Money demand – Practical issues to deal ? Does it bear a stable relationship with Y ? Is the stability held over short term or over long term? ? If M is stable but V changes a great deal in a very short period, how should the monetary authority respond? Should it respond at all? ? If the demand for money is volatile, how does it impact the conduct of monetary policy? Given these issues – how to bring in money demand meaningfully in Monetary Policy ?
What does the RBI do?
The RBI takes a multiple indicator approach to arrive at a view on the current monetary status ? One of the indicators is a perspective on M3 growth ? Projected inflation and GDP growth ? Income velocity (estimated from immediate past data) assumed constant over the policy horizon ? Using the income equation, M3 level is projected ? The growth projection for M3 is used as one of the many indicators to assess monetary situation ? Other macroeconomic indicators such as industrial growth, foreign trade, investment are used to develop a perspective ? rather tentative or discretionary approach
?
The next step
M*V = Py indicates the desired M at a given level of y ? M = m*M0 indicates the level of M0 or reserve money that will produce the desired M ? The RBI thus attempts to influence M via M0 ? Issue is can it get there? ? Even if V is by and large stable, what about P or more importantly, changes in P (inflation) ? ? To what extent can a CB attain a certain inflation scenario? ? m, the money multiplier is a behavioral parameter ? What is the extent of control over all the components and sources of reserve money? ? At times the CB is forced to alter M0 (Intervention in currency market, Fed bailing out banks) ? Is there a clear cut money supply process? Does it always work in the same fashion?
?
Money Supply Process
Additional reserves = 100, c = 25% r = 10% Currency Deposits Bank res Bank credit 8 14.4 10.368 57.6 72
1
2 3
20
80
4
5 6 41.472
5.76
4.15
51.84
37.32
Money Supply Process
The successive rounds of deposit and credit creation would result in ? Deposits = M0/(c+r) = 285.7 ? Bank credit = M0*(1-r)/(c+r) = 257.1 ? Money Supply = M0*(1+c)/(c+r) = 314.3 ? Deposit multiplier = 1/(c+r) ? Bank Credit Multiplier = (1-r)/(c+r) ? Money multiplier = (1+c)/(c+r) ? The issues are ? Is the process as mechanical as depicted above ? Time required for the process to work itself out ? Are there leakages along the way? ? Are there intermediate non-bank transactions? ? What is the extent of total non-bank intermediation ?
?
Summing up
Money supply process works itself out with considerable uncertainty and time lags ? Fiscal actions of government often force a CB to make monetary decisions ? Purchase and sale of foreign currency add further complexities ? The central importance of reserve money still remains ? The impact of the CB actions on the balance sheets of the banks is significant ? Bank reserves are a key element of management of reserve money ? Managing money supply can thus be viewed as a process of managing movements in bank reserves in line with the goals of the monetary policy
?
doc_608154787.ppt
This is a presentation explaining about Demand for Money; Drivers of demand for money; Money Supply Process
Demand for Money – Why bother
? ? ? ? ? ?
Is the current money stock (M3) adequate for the current level of economic activity? How would we know whether it is less or more than what is required ? How fast or slow M3 needs to change given the expected change in economic activity? How fast or slow will output respond to a given a change M3 ? How long the effect will last? What if the response is too weak or in the unintended direction?
Demand for Money – Who bothers
The CB needs answers to such questions ? It thus needs a reliable estimate of demand for money, and ? Some target in relation to which the adequacy or otherwise of the current money stock can be made ? What should that target be – M0, M1 M3, Interest Rate, Inflation, GDP, Employment? ? If M3 is a target, what should be its level? ? To fix that level – say M3 growth of 15% some idea of money demand is essential ? This is not to say that M3 as a target is a must but only to say that if M3 is a target then money demand needs to be estimated
?
Drivers of demand for money
? ?
?
Why individuals and firms hold money? Relative importance of transaction motive (medium of exchange) and speculative motive (store of value) These in turn are influenced by (some illustrative factors) ? Degree of monetization ? Organization of production ? Payment systems – instruments, technology ? Interest rates - current and expected ? Inflation – current and expected
? Degree of vertical integration ? Income intensity of transactions
Demand for money – simple formulation
?
?
?
Income equation ? If Y = P*y (Y nominal income y real income) ? then M*V = P*y (where V is number of time money stock is used in income transactions – final goods and services – recall national income definition). ? V would then be income velocity of money Money demand – Practical issues to deal ? Does it bear a stable relationship with Y ? Is the stability held over short term or over long term? ? If M is stable but V changes a great deal in a very short period, how should the monetary authority respond? Should it respond at all? ? If the demand for money is volatile, how does it impact the conduct of monetary policy? Given these issues – how to bring in money demand meaningfully in Monetary Policy ?
What does the RBI do?
The RBI takes a multiple indicator approach to arrive at a view on the current monetary status ? One of the indicators is a perspective on M3 growth ? Projected inflation and GDP growth ? Income velocity (estimated from immediate past data) assumed constant over the policy horizon ? Using the income equation, M3 level is projected ? The growth projection for M3 is used as one of the many indicators to assess monetary situation ? Other macroeconomic indicators such as industrial growth, foreign trade, investment are used to develop a perspective ? rather tentative or discretionary approach
?
The next step
M*V = Py indicates the desired M at a given level of y ? M = m*M0 indicates the level of M0 or reserve money that will produce the desired M ? The RBI thus attempts to influence M via M0 ? Issue is can it get there? ? Even if V is by and large stable, what about P or more importantly, changes in P (inflation) ? ? To what extent can a CB attain a certain inflation scenario? ? m, the money multiplier is a behavioral parameter ? What is the extent of control over all the components and sources of reserve money? ? At times the CB is forced to alter M0 (Intervention in currency market, Fed bailing out banks) ? Is there a clear cut money supply process? Does it always work in the same fashion?
?
Money Supply Process
Additional reserves = 100, c = 25% r = 10% Currency Deposits Bank res Bank credit 8 14.4 10.368 57.6 72
1
2 3
20
80
4
5 6 41.472
5.76
4.15
51.84
37.32
Money Supply Process
The successive rounds of deposit and credit creation would result in ? Deposits = M0/(c+r) = 285.7 ? Bank credit = M0*(1-r)/(c+r) = 257.1 ? Money Supply = M0*(1+c)/(c+r) = 314.3 ? Deposit multiplier = 1/(c+r) ? Bank Credit Multiplier = (1-r)/(c+r) ? Money multiplier = (1+c)/(c+r) ? The issues are ? Is the process as mechanical as depicted above ? Time required for the process to work itself out ? Are there leakages along the way? ? Are there intermediate non-bank transactions? ? What is the extent of total non-bank intermediation ?
?
Summing up
Money supply process works itself out with considerable uncertainty and time lags ? Fiscal actions of government often force a CB to make monetary decisions ? Purchase and sale of foreign currency add further complexities ? The central importance of reserve money still remains ? The impact of the CB actions on the balance sheets of the banks is significant ? Bank reserves are a key element of management of reserve money ? Managing money supply can thus be viewed as a process of managing movements in bank reserves in line with the goals of the monetary policy
?
doc_608154787.ppt