Question

Monetary Theory

a. Under the quantity theory of money, what is the supply of money when last year's money velocity is estimated to be 1.2, the price level this period at $15, and this period's output at $3 trillion?

b. Suppose one period has passed since part A. The growth rate for this period (t+1) has been found to be 5% and the inflation rate at 2%. What must be this period's money supply, assuming quantity theory holds?

c. Using the Keynesian Portfolio Theory of money and holding all else constant, how will the equilibrium value of money demand change after both of these events occur simultaneously:

1. A new form of payment technology has been invented, making peer-to-peer transactions easier

2. There has been a decline in optimism for investors, decreasing the number of security transactions and causing securities to become less liquid

Answer 1

C) Keynesian portfolio theory of money says that demand for money depends on income rate of return on bonds. Higher the rate of return, higher is the cost of holding money so people hold more bonds and less money. Increase in income leads to increase in the transactions demand for money. Thus a new form of payment technology which makes transaction easier will encourage people to hold checkable deposits instead of money. Negative outlook of business and making securities less liquid will incentivise consumers to hold more money. Thus the net effect on the demand for money is ambigious.