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Economics 2152A/B
Jennifer Mori

Ch 12 Monetary intertemporal model part I Up to now our model has been concerned with real economic variables We now need to put money into the model This will allow us to describe the interest rate and other variables in NOMINAL TERMSThe most important nominal variables will be the interest rate the price level and the inflation rate 1 The nominal interest rate is the real interest rate PLUS the expected amount of inflationRri Where R is the nominal interest rate r is the real rate and i is inflation2 The inflation rate is the rate at which prices continue to rise3 The price level is the magnitude of prices at a point in time If we have money in our economy we must have a demand for that money and a supply of that money The supply of money will simply be assumed to be controlled by the monetary authorities In our model as in many countries the monetary authority will be a central bank eg Bank of CanadaThe demand for money will depend on two variables Output income Y and the nominal interest rate RThere is a positive relationship between the demand for money and Y outputincome and a negative relationship between the demand for money and the interest rate The negative relationship occurs because if interest rates go up agents could purchase a bond ie lend in the credit market and receive a return Thus if they hold money they incur an opportunity costThe positive relationship with Y occurs because as incomes go up agents wish to engage in more transactions buy more goods and services that require moneyThe price level will also have an effect on the demand for money BUT it is OUTSIDE the function PLYR L is just the symbol use to identify the function as a demand for money functionYstands for income output
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