ECON1002 Introductory Macroeconomics
Introductory Macroeconomics
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ECON1002
Introductory Macroeconomics
Week 6 Lecture
Lecture 6
6.1: Money, Prices and the Reserve Bank
What is money?
Money and the banking system
Money and inflation
Reserve Bank of Australia and the determination of interest rates
6.2: The Reserve Bank and the Economy
Bond prices and interest rates
How does the RBA affect all interest rates in the economy?
How does monetary policy affect and respond to the economy?
Case study: Unconventional monetary policy
Readings: Textbook Chs 9 &10.
Otto, Glenn 2007, “Central Bank Operating Procedures: How the RBA achieves its Target for the Cash
Rate”
McLeay, Michael and Radia, Amar and Thomas, Ryland, Money Creation in the Modern Economy
1. Medium of Exchange
Purchase goods & services.
2. Unit of Account
Wages and prices expressed
in dollars (currency)
3. Store of Value
Valued as an asset.
Without money, we would have to
rely on barter.
Money is also a unique asset as it
is supplied by a monopoly – the
government.
Need to satisfy the following
Is the cryptocurrency a money?
What is Money $$$?
In the early days, commodity money was standard. Government operated
a mint to produce coins from precious metals (gold and silver) to generate
seigniorage revenue. What is the problem with this?
Free banking era (private bank notes): In the US (1837-1863), state
chartered (private) banks issued pieces of paper like a currency. What is
the problem with this? N.B. It was followed by National Banking era in the
US (1864-1912).
Commodity-backed paper currency: Government issued paper currency
backed up by some commodity such as gold, exchanged at specified
price, known as the gold standard, (existed in the US before 1933). What
is the problem with this?
Fiat money: Modern money, currency! It has no inherent intrinsic value,
but we believe others accept in exchange for goods in the future. What is
the problem with this?
A Brief History of Money
A Brief History of Central Banks
Amsterdam Wisselbank: A forerunner to modern central banks in 1609.
Sveriges Riksbank (est in 1668): World’s oldest central bank but no monopoly
over printing money before 1904.
Bank of England (est in 1694): takes the form of modern central bank.
US Federal Reserve (est 1913): response to frequent banking panics and
stock market crashes around 1890 - 1912 in the national banking era. Set up
by private banks led by J.P. Morgan.
Reserve Bank of Australia (Reserve Bank Act 1959): took over the central
banking function from the Commonwealth Bank (est 1911). Australian dollar
introduced in 1966 to replace Australian pound.
Currency = notes + coins
M1 = Currency + current deposits
M3 = M1 + all bank deposits
Broad Money = M3 + borrowings by Non-
Bank depository corporations less holdings
of currency and deposits of Non-Bank
depository corporations
Less Liquid
Monetary Aggregates: Definitions
A Theory of Money and Inflation
Intuition: Suppose there are $100 in an economy, and there is
one transaction occurred to buy 20 units of a good priced $5.
Equation of Exchange: MV = PT, ($100*1 = $5*20).
an identity which must be true
V = PT/M ; velocity (frequency) of circulation
At the aggregate level, Real GDP (Y) is a quantity,
proportional to transactions (T). So replace T with Y.
Hence, MV = PY (where V = PY/M, PY = Nominal GDP)
This is the quantity equation of money.
% % % %
MV PY
M V P Y
=
∆ + ∆ = ∆ + ∆
% %M P∆ = ∆
Assume
(1) V is
constant
(2) Y is
constant
A Theory of Money and Inflation
Money vs Inflation & Output
Source: "Some Monetary Facts" (Federal Reserve Bank of Minneapolis Quarterly Review, 1995)
Inflation is a monetary phenomenon in the LR! Money is neutral in the LR!
Money and Inflation in US Data
Reserves to deposits ratio = 100%
Fractional Banking System
Balance Sheet of Witch Bank: Initial
Reserves to deposits ratio = 10%
Money and Banks