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Lecture Macroeconomics: Lecture 26 - Prof. Dr.Qaisar Abbas

Lecture 26: Money supply and money demand - I. After studying this chapter you will be able to understand: how the banking system “creates” money, fractional-reserve banking, money creation in the banking system. | Review of the previous lecture 1. Investment is the most volatile component of GDP over the business cycle. Fluctuations in employment affect the MPK and the incentive for business fixed investment. Fluctuations in income affect demand for, price of housing and the incentive for residential investment. Fluctuations in output affect planned & unplanned inventory investment. 0 Lecture 26 Money Supply and Money Demand-I Instructor: Prof. Dr. Qaisar Abbas 1 This chapter sets up the IS-LM model, which chapter 11 then uses extensively to analyze the effects of policies and economic shocks. This chapter also introduces students to the Keynesian Cross and Liquidity Preference models, which underlie the IS curve and LM curve, respectively. If you would like to spend less time on this chapter, you might consider omitting the Keynesian Cross, instead using the loanable funds model from Chapter 3 to derive the IS curve. Advantage: students are already familiar with the loanable funds model, so . | Review of the previous lecture 1. Investment is the most volatile component of GDP over the business cycle. Fluctuations in employment affect the MPK and the incentive for business fixed investment. Fluctuations in income affect demand for, price of housing and the incentive for residential investment. Fluctuations in output affect planned & unplanned inventory investment. 0 Lecture 26 Money Supply and Money Demand-I Instructor: Prof. Dr. Qaisar Abbas 1 This chapter sets up the IS-LM model, which chapter 11 then uses extensively to analyze the effects of policies and economic shocks. This chapter also introduces students to the Keynesian Cross and Liquidity Preference models, which underlie the IS curve and LM curve, respectively. If you would like to spend less time on this chapter, you might consider omitting the Keynesian Cross, instead using the loanable funds model from Chapter 3 to derive the IS curve. Advantage: students are already familiar with the loanable funds model, so skipping the KC means one less model to learn. Additionally, the KC model is not used anywhere else in this textbook. Once it’s used to derive IS, it disappears for good. However, there are some good reasons for NOT omitting the KC model: 1) Many principles textbooks (though not Mankiw’s) cover the KC model; students who learned the KC model in their principles class may benefit from seeing it here, as a bridge to new material (the IS curve). 2) The KC model has historical value. One could argue that somebody graduating from college with a degree in economics should be familiar with the KC model. Lecture Contents Money supply how the banking system “creates” money 2 Banks’ role in the money supply The money supply equals currency plus demand (checking account) deposits: M = C + D Since the money supply includes demand deposits, the banking system plays an important role. 3 A few preliminaries Reserves (R ): the portion of deposits that banks have not lent. To a bank, liabilities include