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Asset Markets
• Let’s take a closer look at this market.
Money MarketFinancial MarketBond Market
Equities Market
Money Market
• What is money?Without it, modern economies could not function
Historical Development of Money• No Money: Barter Economy (goods for goods)• Money as a medium of Exchange:
Goods Money Goods
Lydian Coin (Western Turkey), 700-637 B.C.• How did all start? (shells, barley, peppercorns, gold, and silver)
– Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)
–
History of money
– Precious metals, (Metals objects were introduced as money around 5000 B.C. By 700 BC, the Lydians became the first in the Western world to make coins.)
– Paper money (fully) backed by gold,– Paper money fractionally backed by gold,– Fiat money,
Chinese note 1368-1399 (size of a sheet of notebook paper)
Properties of a Good Medium of Exchange
1. Acceptable 2. Standardized quality (diamonds, clear or not)3. Durable (fish, strawberry, do they last)
4. Valuable relative to its weight (cement)5. Divisible (diamonds, pay for bread)
The Functions of Money
1) Medium of Exchange2) Unit of account3) Store of Value New York Note, 1776
4) Standard of deferred payments
Precious metals are easily divisible into standardized coins and do not lose value when made into smaller units : COINS
Initial stages of development of money
• Coins, • “Bank Notes” start of Paper money,– Fully backed by gold.– Fractionally backed by gold,
• Fiat Money What is the supply? (more efficient)
Why is money important?
• Using standardized coins or paper bills made it easier to determine prices of goods and services,
• the amount of money in the system also plays an important role in setting prices.
Inflation or deflation
Money Supply
Delegated to Central Banks
Money Supply Today
• Money supply (M1)Currency (in circulation) + demand deposits (TL and Foreign Currency)
229,091,917,800 TL
• Money supply (M2)M1 + Time deposits (TL and Foreign Currency)
930,652,330,000 TL
M1 and M2 in Turkey
2005 2006 2007 2008 2009 2010 2011 20120
100000000
200000000
300000000
400000000
500000000
600000000
700000000
800000000
M1M2
US Money Supply
Nov. Dec. Jan. 2011
Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. 2012
Feb. Mar. Apr. May June July Aug. Sep. Oct.0
2000
4000
6000
8000
10000
12000
M1M2
Can the Central Bank change MS?
• YES!!!
• HOW? – With some tools known as monetary policy tools.
(Tools are instruments that a policy maker can change in order to influence the workings of an economy)
Monetary Policy Tools
1. Discount Rate,2. Reserve Requirement ratio,3. Open Market Operations.
How do they work? Need to look at how banking system work and money changes hands…
Commercial Banks
• Banks are profit seeking institutions.– They accept deposits,– They give loans
• Public Banks (Ziraat, Halk …) and Private banks (IsBank, Akbank, Garanti
…)
Commercial Banks Balance SheetsAssets Liabilities
Reserves Deposits
Loans Short and long term borrowing
Building and Equipment Other Liabilities
Other Assets
Total Liabilities
Stock holders equities
Total Assets Total liabilities + stock holders’ equities
Rules that commercial banks follow:
• Hold the required reserve ratio determined by Central Bank.
If required reserve ratio (rr) is 15%, then in equilibrium
(Reserves/ Deposits)*100 ratio=15 %.
e.g. If Total Deposits are 2000 billion TL, then reserves need to be 300 billion TL.
(Reserves/ Deposits)*100 ratio=(300/2000)*100=15 %
A new deposit comes into Bank One
Change Assets Change LiabilitiesReserves +1000 Deposits +1000
Loans
Total Assets +1000 Total Liabilities +1000
Bank One uses this new deposits in giving out new loans
(Reserves/deposits)*100= 15 %. Result: Creates a new loan equal to 850.
Change Assets Change Liabilities
Reserves + 150 Deposits +1000
Loans + 850
Total Assets +1000 Total Liabilities +1000
The new loan comes back to Bank Two Change Assets Change LiabilitiesReserves +850 Deposits +850
Loans
Total Assets +850 Total Liabilities +850
Change Assets Change LiabilitiesReserves +127.5 (850*0.15) Deposits +850
Loans +722.5 (850*0.85)
Total Assets +850 Total Liabilities +850
New loans of 722.5 TL are created by Bank Two
This will repeat ∞ times
• Total change in the deposits: 1000+ (0.85*1000)+(0.85*1000)2+(0.85*1000)3+…
(0.85*1000)∞
• Total change =
• Change in total deposits=
Money supply
• Money market • Tools to increase the MS1) Discount rate increase,2) Reserve requirement
ratio decrease,3) Open Market
Operations (Buy bonds)
I
Q of money
Money demand
• Money market • Types of Money demand
1) Transaction demand,2) Speculative demand,3) Precautionary
demand,
• MD= L(Y, i) or• MD= 5*Y – 3*i
I
Q of money
Money demand
• Money market • If Y increases, then MD curve shifts to the right
• MD= L(Y, i) or• MD= 5*Y – 3*i
I
Q of money
Money market equilibrium
• Money market MS=MD
• Money supplyMS= 1000
• Money demandMD= L(Y, i) orMD= 5*Y – 3*I
(For a given Y level you will be able to determine equilibrium interest rate)
I
Q of money
Money market equilibrium
• Money market MS=MD
• Money supplyMS= 1000
• Money demandMD= L(Y, i) orMD= 5*Y – 3*I
(For a given Y level you will be able to determine equilibrium interest rate)
I
Q of money
Determination of output
• Equilibrium in 1. GOODS and SERVICES Market and 2. MONEY Market
(Demand side of the economy)
Goods and Money Markets
What is in the model?
GOODS MARKET• The AEd= Y equality
• Other variables:Cd, Id, Gd, NXd, T, YD,
------------------------------IS Curve
MONEY MARKET• MD=MS equality
• Other variables:Y, i
--------------------------------LM Curve
IS – LM model
• Money Market• Goods marketi
Y
i
Y
IS LM
IS curve
IS-LM equilibrium
• Equilibrium in both markets
i
Y
ISLM
IS-LM equilibrium
• Expansionary Monetary Policy
i
Y
ISLM
IS-LM equilibrium
• Expansionary Fiscal Policy:
i
Y
ISLM
Mathematical model of the IS-LM
• See class notes and homework assignment