Role of Money and Credit

1
Chapter 3

• Role of Money and Credit

Money is like muck -- not good unless you spread
it. - Francis Bacon
2
Money and Credit Matter

• Cause and consequence of money and credit flows
  in economy
• Feedback nature of these relationships may create
  chicken-and-egg dilemma
• Start with identifying/analyzing factors
  affecting demand for and supply of money

3
Demand for Money

• Quantity demanded at different interest rates
• Inverse relationship with interest rates
• Demand for money
• Entire set of combinations of quantity demanded
  and interest rates
• Changes result in shift in demand curve

4
The Demand for Money
5
Changes in the Quantity Demanded of Money Versus
Changes in the Demand for Money
6
Supply of Money

• M1 currency checkable deposits
• Reserves held against checkable deposits
• Vault cash or deposits with Fed
• Role of Fed in supply of money
• Sets required reserve ratio
• Influences cash assets outstanding

7
Supply of Money

• Quantity supplied at different interest rates
• Controlled by Fed
• No relationship to interest rates (perhaps)
• Supply of money
• Vertical line at a particular level
• Same quantity supplied no matter the interest
  rate
• Changes result in shift in supply curve

8
The Supply of Money
9
Changes in the Supply of Money
10
Money and Interest Rates

• Interaction between supply of and demand for
  money
• Determines availability (quantity)
• Determines cost (interest rate)

11
Market Equilibrium
Supply
Interest Rate (Percent)
ie
Demand
Quantity of Money
12
An Increase in the Demand for Money
13
An Increase in the Supply of Money
Interest Rate (Percent)
SS
S'S'
i e
i' e
Demand
Quantity of Money
14
How Money Matters An Illustration
Federal Reserve Acts
Interest Rates, Money Supply, and Credit Flows
Changes
Aggregate Demand for Goods and Services Shifts

Economys Output and Prices Respond
15
How Credit Matters

• Credit Flow of money to DSUs
• Supply of money related to supply of credit
• Decreasingly
• DNFD credit outstanding
• Borrowing power

16
Sources of credit flows

• Changes in credit from depository institutions
• Changes in lending at nondepository financial
  institutions
• Abroad

17
Money, Credit and Economy

• Money/credit flows impact real economic activity
• Current inflation influenced by prior changes in
  money supply and credit growth
• Changes in money/credit closely correlated with
  changes in nominal GDP

18
Money, Output, and Inflation
Sustained Rise in Money and Credit Growth Rate
Increases in Inflation with a Lag
Increases in Output (Real and Nominal GDP)
Decreases in Inflation with a Lag
Sustained Fall in Money and Credit Growth Rate
Decreases in Output (Real and Nominal GDP)
19
Are Money and Credit All That Matter?

• Correlations among money supply growth, credit
  flows and economic activity not perfect
• Other factors also an influence
• Fiscal policy (current and future)
• Expectations about future monetary policy
• Future inflation

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Implications of current happenings

• Factory orders 1.3 in August
• Largest change in 4 months
• Productivity increased by 2.5
• Slower growth than previous