25 MONEY, THE PRICE

LEVEL, AND
INFLATION
After studying this chapter, you will be able to:

◆ Define money and describe its functions

◆ Explain the economic functions of banks

♦ Describe the structure and functions of the Federal

Reserve System (the Fed)

♦ Explain how the banking system creates money*****

◆ Explain what determines the quantity of money and the

nominal interest rate
◆ Explain how the quantity of money influences the price
level and the inflation rate
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Money ( 貨幣 ) has been around a long time and has taken
many forms. Ex: whale’s teeth (Fijians), tobacco (north
Americans), cakes of salt (Tibetans) , wampum beads ( 有孔
小珠貝殼串 , Native American).

Today, we use dollar bills or swipe a card or, in some

places, tap a cell phone. Are all these things money?

What happens when the bank lends the money we’ve

deposited to someone else?

How does the Fed influence the quantity of money?

What happens when the Fed creates too much money?

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 What is Money?

Money is any commodity or token that is generally

acceptable as a means of ( 作為 ~ 的方法、方式 ) payment.
A means of payment is a method of settling a debt.
Money has three other functions:
▪ Medium ( 媒介 vs median) of exchange (median size)
▪ Unit of account
▪ Store of value

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 What is Money?

Medium of Exchange
A medium of exchange is an object that is generally
accepted in exchange for goods and services.
In the absence of money, people would need to exchange
goods and services directly, which is called barter ( 以物易物
not butter).
Barter requires a double coincidence ( 巧合 , 同時發生 ) of
wants, which is rare, so barter is costly. (chicken for a
desk?)

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 What is Money?
Unit of Account
A unit of account is an agreed
measure for stating the prices
of goods and services.
Table 25.1 illustrates how
money simplifies
comparisons.
Store of Value
As a store of value, money
can be held for a time and
later exchanged for goods
and services. . (car, house,
painting?) inflation matters?
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 What is Money?

Money in the United States Today

Money in the United States consists of
▪ Currency
▪ Deposits at banks and other depository institutions
Currency ( 通貨 , 貨幣 ) is the notes and coins held by
individuals and businesses.
The notes and coins inside banks are not currency
because they are not held by individuals and businesses.
Deposits are money because the owners can use the
deposit to make payments.

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 What is Money?

Official Measures of Money

The two main official measures of money ( 貨幣數量的定義 )
in the United States are M1 and M2.
M1 (M1a & M1b) consists of currency plus demand
deposits and other liquid deposits owned by individuals
and businesses that can be withdrawn on demand.
M2 consists of M1 plus small-denomination ( 面值 nominal
value) time deposits and retail money market mutual
funds. (UK: term deposit= US: time deposit)

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 What is Money?

The figure illustrates the

composition of M1…
and M2.
It also shows the relative
magnitudes of the
components.

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 中央銀行採用的貨幣定義

M1a = 通貨淨額 + 支票存款 + 活期存款 ( 流動性最高 )

M1b = M1a + 活期儲蓄存款
( 活存和活儲兩者最大的差異在於開戶的資格、利率、利息不同，前者的開戶資格通常沒有限制，而後者僅限個
人、非營利法人開立的銀行帳戶，且利率會比前者來的高一些 )
M2 = M1b + 郵匯局存簿儲金 + 定期存款 + 定期儲蓄存款 + 外匯存款 (2025/03:
郵政存簿儲金年利率 0.830%)
OR M2 = M1b + 準貨幣（主要是定期性存款）

銀行利率查詢利率比較表 TaiwanRate.com

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 定期存款與定期儲蓄存款有何不同 ? (from 永豐銀行 )

定期存款：開戶最低金額為 NT10,000 以上，期限為 1 至 36 個月止，利

息可每月領取亦可到期一併領取，皆為單利計息。
定期儲蓄存款：開戶最低金額為 NT10,000 以上，期限為 12 至 36 個月
止，利息可每月領取亦可到期一併領取，若為到期一併領取則可複利計息。開
戶資格必須為個人或非營利法人，以儲蓄資金為目的之定期存款

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 What is Money?
Are M1 and M2 Really Money?
Money is the means of payment.
Currency is money.
Demand deposits ( 活期存款 , AU: savings account) can be
transferred from one person to another by a check or
direct debit, so they are money.
Other liquid deposits are easily convertible into a means
of payment without loss in value, so they are money.
Small-denomination ( 小額面額 ) time deposits and retail
money market funds are not a means of payment, but
they are quickly and easily converted into a means of
payment, so they are counted as money.
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儲蓄存款的存戶一般限於個人。
傳統的儲蓄存款不能開支票進行支付 , 可以獲得利息。這種存款通常由銀行給存款人發一張存摺，
作為存款和提取存款的憑證。
儲蓄存款的存摺不具有流通性，不能轉讓 (?) 和貼現。
Liquidity ( 流動性 ) is the property of being instantly
convertible into a means of payment with little loss of
value.

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 What is Money?

Deposits Are Money but Checks and Debit Cards Are Not
A check or card swipe is an instruction to a bank to transfer
money.
A check or card swipe is not money, but the deposit on which
it is linked is money.
Credit Cards and Mobile Wallets Are Not Money
A credit card enables the holder to obtain a loan, but it must
be repaid with money. Credit cards are not money.
A mobile wallet is a smartphone or smartwatch app that
stores and accesses credit card or debit card data to make
purchases. It is not money.
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 Depository Institutions

A depository institution is a firm that takes deposits from

households and firms and makes loans to other
households and firms.
Types of Depository Institutions
Deposits at three institutions make up the nation’s money.
They are
▪ Commercial banks ex: 玉山、台新
▪ Thrift [ 儲蓄 ( 節儉 )] institutions
▪ Money market mutual funds ( 貨幣市場共同基金 ; 以貨幣市場為投資標的
之共同基金 )

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 Depository Institutions

Commercial Banks
A commercial bank is a private firm that is licensed by the
Comptroller ( 審計官 ) of the Currency or by a state agency to
receive deposits and make loans.
Thrift Institutions
Savings and loan associations, savings banks, and credit
unions are called thrift institutions.
Money Market Mutual Funds
A money market mutual fund is a fund operated by a
financial institution that sells shares in the fund and holds
assets such as U.S. Treasury bills ( 國庫券 : 短期公債 ).
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 貨幣市場共同基金

共同基金是將眾多的小額投資者的資金集合起來，由專門的經理人進行市場運作，賺取收益後按一
定的期限及持有的份額進行分配的一種金融組織形式。而對於主要在貨幣市場上進行運作的共同基
金，則稱為貨幣市場共同基金，貨幣市場共同基金的管理者就利用這些資金投資於可獲利的短期貨
幣市場工具（例如國庫券和商業票據等）。
貨幣市場共同基金是一種特殊類型的共同基金，是美國 20 世紀 70 年代以來出現的一種新型投
資理財工具。 ( 不同於股票型基金、債劵型基金 )

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 Depository Institutions

What Depository Institutions Do

The goal of any bank is to maximize the wealth of its
owners.
To achieve this objective, the interest rate at which it lends
exceeds the interest rate it pays on deposits.
But the banks must balance profit and prudence ( 審慎 , 慎重
risk):
▪ Loans generate profit.
▪ Depositors must be able to obtain their funds when
they want them.

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 Depository Institutions

A commercial bank puts the depositors’ funds into three

types of assets:
1. Cash assets—notes and coins in its vault ( 銀行的“金庫” , 地
下儲藏室 , 地窖 , jump) or its deposit at the Federal Reserve
2. Securities—U.S. government Treasury bills and
commercial bills and longer-term U.S. government
bonds and other bonds such as mortgage-backed
securities
3. Loans—commitments of fixed amounts of money for
agreed-upon periods of time

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 Depository Institutions

Table 25.2 shows the

sources and uses of
funds in all U.S.
commercial banks in
June 2021.

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 Depository Institutions

Economic Benefits Provided by Depository Institutions

Depository institutions make a profit from the spread
between the interest rate they pay on their deposits and the
interest rate they charge on their loans.
Depository institutions provide four benefits: ( 銀行的存在有 4 個
好處 )
1. Create liquidity (borrowing short, 指民眾的存款 but lending
long)
2. Pool risk (1 out of 1000 people defaults, so?)
3. Lower the cost of borrowing (for firms)
4. Lower the cost of monitoring borrowers
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 Depository Institutions

How Depository Institutions Are Regulated

Depository institutions engage in risky business.
To make the risk of failure small, depository institutions
are required to hold levels of reserves and owners’ capital
equal to or surpass ratios laid down by regulation.
存款保險 : If a depository institution fails, deposits are
guaranteed up to $250,000 per depositor per bank by
FDIC—Federal Deposit Insurance Corporation. (how about
Taiwan?)

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 中央存款保險公司

我國銀行法 46 條規定：「為保障存款人之利益，得由政府或銀行設立存款保險之組織」。 政
府設立中央存款保險公司的宗旨，依「存款保險條例」法律規定有下列三項：
1. 保障金融機構存款人權益。
2. 維護信用秩序。
3. 促進金融業務健全發展。
– The government-owned Central Deposit Insurance Corporation (CDIC)
was established on September 27, 1985 ( 台北十信 ), with capital jointly
invested by the Ministry of Finance and the Central Bank of China. CDIC
is the only institution in Taiwan exclusively in charge of managing the
deposit insurance system and serves as an integral part of the
country's financial safety net.

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 中央存款保險公司

凡經依法核准收受存款、郵政儲金或受託經理具保本保息之代為確定用途信託資金 ( 以下合稱存款 ) 之金融機構，經

中央存保公司審核許可加入存款保險者，應依規定於各營業處所明顯處，懸掛中央存保公司發給的大型「存款保險標示
牌」（詳附檔），民眾十分容易辨識。

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 金融機構參加存款保險概況表 113/02/29
金融機構別 可投保家數 已投保家數
本國銀行 36 36
外國及大陸地區銀行在臺分行 31 30
信用合作社 23 23
民營金融機構
農會信用部 283 283
漁會信用部 28 28
小計 401 400
銀行 Q 2 2
公營金融機構 中華郵政公司 1 1
小計 3 3
合計 404 403

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 劉揆一句話 政策大轉彎！金管會：存款保險改為
全額保障
2008/10/07 21:09 記者顏真真／台北報導
金管會 6 日才宣布將存款保險最高保額由新台幣 150 萬元提高為 300 萬元，行政院長劉兆玄 7 日就
在立院公開宣示「所有國內銀行存款戶的存款由政府保障」，讓金管會趕緊在晚間再宣布，自即刻起存款保
險改為全額保障，而且不限新台幣存款，還包括外幣存款、銀行同業拆借都納入保障範圍，至於實施期限，
仍待這兩天會商後才能決定。
全球信用緊縮恐懼風暴擴大，各國紛紛採行穩定信用措施，金管會在 6 日晚間 11 時 10 分宣布，將金融
機構存款人的最高保額由新台幣 150 萬元提高為 300 萬元，並至 98 年 12 月 31 日止。不過，
劉揆 7 日上午卻又當著立委面前承諾給予全額保障。 ( 於 97 年 10 月宣布至 98 年 12 月 31 日前，對
本公司之要保機構，其存款人之所有存款均全額保障，不受最高保額之限制。 98 年 10 月宣布全額保障措施延長一年至 99 年 12
月 31 日止 )

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 Depository Institutions

Financial Technology
In the pursuit of larger profit, depository institutions are
constantly seeking ways to improve their products in a
process called financial innovation.
The development of low-cost computing and
communication brought financial innovations such as
credit cards and daily interest deposit accounts, ex: HSBC.
Financial innovation has changed the composition of
money. As percentage of M1, demand deposits have
increases while other liquid deposits have decreased.
Also money market mutual funds in M2 have increased.
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 The Federal Reserve System

The Federal Reserve System (the Fed) is the central

bank of the United States.
A central bank is the public authority that regulates a
nation’s depository institutions and control the quantity
of money (QE1, QE2, QE3…). quantitative easing
The Fed’s goals are to keep (1) inflation in check ex: 中央
銀行無預警升息半碼 2024/03/22, (2) maintain full employment,
(3) moderate the business cycle, and (4) contribute toward
achieving long-term growth.
In pursuit of its goals, the Fed pays close attention to the
federal funds rate - the interest rate that banks charge
each other on overnight loans of reserves.

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 The Federal Reserve System

The Structure of the Fed

The key elements in the structure of the Fed are
▪ The Board of Governors (7 members)
▪ The regional Federal Reserve banks (12 districts)
▪ The Federal Open Market Committee (7 + NY+ 4
others), 12 區選 4 位

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 The Federal Reserve System

The Board of Governors

Has seven members appointed by the president of the
United States and confirmed by the Senate.
Board terms are for 14 years and terms are staggered ( 錯
開 , 交錯安排 ; 搖搖晃晃 ) so that one position becomes vacant
every 2 years.
The president appoints one member to a (renewable) four-
year term as chairman.
Each of the 12 Federal Reserve Regional Banks has a
nine-person board of directors and a president.

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 The Federal Reserve System

The Federal Reserve Banks

Figure 25.1 shows the 12 regions.

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 The Federal Reserve System

The Federal Open Market Committee

The Federal Open Market Committee (FOMC) is the
main policy-making group in the Federal Reserve System.
It consists of the (7) members of the Board of
Governors, the president (1) of the Federal Reserve Bank
of New York, and the 11 presidents of other regional
Federal Reserve banks of whom, on a rotating basis, 4 are
voting members. (=7+1+4=12 位 )
The FOMC meets every six weeks to formulate monetary
policy.

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 The Federal Reserve System

In practice, the chair of the Board of Governors (Jerome

Powell since 2018) has the largest influence on the Fed’s
policy.
Powell controls the agenda of the Board, has better
contact with the Fed’s staff, and is the Fed’s spokesperson
and point of contact with the federal government and with
foreign central banks and governments.

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 The Federal Reserve System

The Fed’s Balance Sheet

The Fed influences the economy through the size and
composition of its balance sheet—the assets that the Fed
owns and the liabilities that it owes.
The Fed’s two main assets are U.S. government
securities and mortgage-backed securities.
The Fed’s two liabilities are currency and reserves of
depository institutions
The Fed’s total liabilities (currency and depository
institutions’ deposits at the Fed) is the monetary base ( 貨
幣基數 )..
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 The Federal Reserve System

Table 25.3 shows the

sources and uses of
the monetary base in
June 2021.
The Fed’s assets are
the sources of
monetary base.
The Fed’s liabilities
are its uses of
monetary base.

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 The Federal Reserve System

The Fed’s Policy Tools 背 !

To achieve its objectives, the Fed uses three main
policy tools:
1. Open market operations ( 公開市場操作 )
2. Discount window and discount rate
3. Interest on reserves rate

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 The Conduct of Monetary Policy

Open Market Operations

An open market operation is the purchase or sale of
government securities by the Fed from or to a commercial
bank or the public.
When the Fed buys securities, it pays for them with newly
created reserves held by the banks.
When the Fed sells securities, they are paid for with
reserves held by banks.
So open market operations influence banks’ reserves.

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 The Conduct of Monetary Policy

An Open Market Purchase

Figure 25.2 shows the
effects of an open market
purchase on the balance
sheets of the Fed and the
Bank of America.
The open market purchase
increases the Fed’s assets
and liabilities.

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 The Conduct of Monetary Policy

An Open Market Sale

This figure shows the
effects of an open
market sale on the
balance sheets of the
Fed and the Bank of
America.
The open market sale
decreases the Fed’s
assets and liabilities.

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 央行三度升息 364 天期定存單利率飆 12 年半來
最高
2022-10-03 19:03 經濟日報／ 記者陳美君／即時報導

中央銀行今（ 3 ）日標售 364 天期定存單，金額為 1,400 億元，得標利率落於

1.259% ，連兩月上漲，並創 2010 年 4 月、央行重啟定存單標售以來的 12 年新高，標
售結果符合市場預期。銀行資調主管說，反映央行 9 月升息半碼，今天標售的定存單得標利率
較前一期上漲 0.077 個百分點
央行發行定存單，是為了去化銀行手頭上的餘裕資金，目前央行每月均固定標售一期 364 天
期與 2 年期定存單，金額分別為 1,400 億元與 250 億元。
銀行主管說，長期以來國內資金水位都非常充裕，為避免游資過多助長通膨火焰，央行發行定
存單回收餘裕頭寸，因此，央行定存單的餘額水位，也被視為國內銀行「爛頭寸」多寡的重要
指標，從央行定存單餘額銳減可知，央行今年採取一系列緊縮性貨幣政策，爛頭寸水位已明顯
下降。

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 The Federal Reserve System

Discount Window and Discount Rate

The “discount window” is an imaginary window that is
always open and through which the Fed makes loans to
commercial banks and other depository institutions.
These “last resort loans” ensure that banks are always
able to meet withdrawals by their customers.
The discount rate ( 貼現率 ) is the interest rate paid by
discount window borrowers. The Fed’s Board of
Governors sets this interest rate.

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 14 年來首度調升存準率 1 碼 央行出大招鎖住銀行
資金
2022-06-17 03:04 經濟日報／ 記者陳美君、楊筱筠、廖珮君、夏淑賢／台北報導

中央銀行睽違 14 年，再度動用調升存款準備率這一招。央行官員指出，央行
前次調升存準率是在 2008 年 7 月，當時為國際金融海嘯爆發前，不僅通膨
高漲，國內還有油電雙漲背景，調整存準率代表央行「鎖住」銀行的資金、減
少銀行可貸放的資金量、進而影響銀行的放款意願
央行總裁楊金龍指出，存準率調漲 1 碼，代表銀行要存放在央行的現金變多
了，大約會收回 1,200 億元的市場資金，且調整存準率不會直接影響到銀行
的存放款利率，但會縮減銀行的流動性，影響授信、投資商業本票、公司債等
市場的意願，對 M2 （貨幣供給額）的控制長期下來會有明顯助益。

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央行升息半碼又拉高存準率一碼，被市場視為「價與量」雙管齊下。銀行主管
說，升息半碼影響的是一般民眾存放款利率，存準率升 1 碼則是加大抽回市場
游資力道，間接緊縮了銀行放款，央行從放款供給面下手，供給面一旦減少
了、也會有拉升市場利率效果

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 The Federal Reserve System

Interest on Reserves Rate

The interest on reserves rate is the interest rate that
banks earn on their reserves held on deposit at the
Fed.
In 2021, the Fed announced that it would pay interest on
all reserve balances, both required reserves and excess
reserve.
Like the discount rate, the Board of Governors sets this
interest rate.

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 How Banks Create Money

Creating Deposits by Making Loans 太重要了 !!!!!!!

Banks create deposits (when they make loans) and the
new deposits created are new money.
The quantity of deposits that banks can create is limited by
three factors:
▪ The monetary base 貨幣基數 (C+R; 通貨 + 存款準備 )
▪ Desired reserves (b)
▪ Desired currency holding

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 How Banks Create Money

The Monetary Base

The monetary base is the sum of Federal Reserve notes,
coins, and banks’ deposits at the Fed.
The size of the monetary base limits the total quantity of
money that the banking system can create because
1. Banks have desired reserves ( 銀行需要保留一些錢 )
2. Households and firms have desired currency holdings ( 民
眾也要現金 )
And both these desired holdings of monetary base depend
on the quantity of money.

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 How Banks Create Money

Desired Reserves
A bank’s actual reserves ( 準備金 ) consists of notes and
coins in its vault and its deposit at the Fed.
desired reserve are the reserves that a bank determines
to be prudent for its daily business.
The desired reserve ratio ( 自己要的存款準備率 ) is the ratio of
the bank’s reserves to total deposits that a bank plans to
hold.
Actual (ex:13%) reserves minus desired (ex: 想要 12%)
reserves are unplanned reserves (=excess reserve).

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 How Banks Create Money

Desired Currency Holding

People hold some fraction of their money as currency.
So when the total quantity of money increases, so does
the quantity of currency that people plan to hold.
Because desired currency holding increases when
deposits increase ( 存款增加，現金持有量當然也會增加 ), currency
leaves the banks (when they make loans and increase
deposits).
This leakage of reserves into currency is called the
currency drain ( 就是存款減少變成通貨稱為 “通貨外流” ).
The ratio of currency to deposits is called the currency
drain ratio (C/D).
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 How Banks Create Money
The Money Creation Process
The money creation process begins with an increase in the
monetary base.
The Fed conducts an open market operation in which it buys
securities from banks.
The Fed pays for the securities with newly created bank
reserves.
Banks now have more reserves but the same amount of
deposits, so they have unplanned reserves.
Unplanned reserves(1%) = Actual reserves(13%) – desired reserves
(12%) 本來 actual reserves (13%) = desired reserves(12%), but the Fed
buys securities from banks, actual reserves increases by 1% (no change
to bank’s deposits).
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 How Banks Create Money

Figure 25.3 illustrates one round in how the banking

system creates money by making loans.

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 How Banks Create Money
The Money Multiplier ( 貨幣乘數 )
The money multiplier is the ratio of (the change in the quantity of
money) to (the change in the monetary base).
For example, if the Fed increases the monetary base by $100,000
and the quantity of money increases by $250,000, the money
multiplier is 2.5.
The quantity of money created depends on the desired reserve
ratio (rd: 法定存款準備金率 ) and the currency drain ratio (C/D).
The smaller these ratios ( 隱含分母越小 ), the larger is the money
multiplier.
貨幣乘數 (m) =“ 貨幣供給量（通貨＋存款貨幣 , C+D ）的變動” 除以 “貨幣基數
(C+R) 的變動”。 R: 存款準備 = rd x deposit

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 貨幣乘數 (mm)

流通在外的通貨 C 存在中央銀行的存款準備 R 兩者都是中央銀行的負債，可以統稱為

強力貨幣 (high-powered money) 或 貨幣基數 (monetary base)
B=C+R
貨幣乘數 (mm) 就是貨幣數量 M 與準備貨幣 B 之間的倍數關係 , rd = R/D

C
+ 1
M C+D D
mm = = =
B C+R C R
+
D D

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 The Money Market

The money market is a virtual market in which households

and businesses demand money, the Fed and the banks
supply money, and an equilibrium quantity of money and
interest rate are determined.
The Demand for Money
The demand for money (vs demand for loanable funds) is
the relationship (between the quantity of money demanded
and the nominal interest rate) when all other influences
remain the same.
The quantity of money demanded depends on the
opportunity cost of holding money —the nominal interest
rate forgone by not holding an interest-earning asset.
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 The Money Market

Figure 25.4 illustrates the

demand for money curve.
As the interest rate rises,
the quantity of money
demanded decreases.
As the interest rate falls,
the quantity of money
demanded increases.

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 The Money Market

Changes in the Demand for Money

The quantity of money that people plan to hold depends
on three main factors:
1. The price level
2. Real GDP
3. Financial innovation

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 The Money Market

The Price Level

A rise in the price level increases the quantity of nominal
money but doesn’t change the quantity of real money that
people plan to hold.
Nominal money is the amount of money measured in
dollars.
Real money equals nominal money ÷ price level.
The quantity of nominal money demanded is proportional
to the price level—a 10 percent rise in the price level
increases the quantity of nominal money demanded by 10
percent.

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 The Money Market

Real GDP
The quantity of money that households and firms plan to
hold depends on the amount they are spending.
The quantity of money demanded in the economy as a
whole depends on aggregate expenditure—real GDP.
An increase in real GDP increases the aggregate
expenditure, which increases the demand for money.
Financial Innovation
Financial innovation that lowers the cost of switching
between money and interest-earning assets decreases the
demand for money.
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 The Money Market

Changes in the Demand

for Money
Figure 25.5 shows that a
decrease in real GDP or a
financial innovation
decreases the demand for
money and shifts the
demand curve leftward.
An increase in real GDP
increases the demand for
money and shifts the
demand curve rightward.
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 The Money Market

The Supply of Money

The supply of money is the relationship (between the
quantity of money supplied and the nominal interest rate)
when all other influences on the amount of money that the
Fed and banks wish to create remain the same.
The quantity of money supplied is the quantity of currency
and deposits that the Fed and the banks plan to create on
any given day.
Note: demand and supply for loanable funds, Y-axis is
REAL interest rate

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 The Money Market

The Fed is the most powerful player in the money market,

so the supply of money depends on the Fed’s monetary
policy strategy.
In conducting its monetary policy, the Fed can target the:
1. Monetary base
2. Nominal interest rate
3. Quantity of money

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 The Money Market

1. Target the Monetary Base

If the Fed targets and sets the monetary base, a rise in the
nominal interest rate increases the quantity of money
supplied.
A higher interest rate makes loans more profitable for the
banks, so they decreases their desired reserve ratio,
which increases the quantity of money supplied by a given
monetary base.
A change in the monetary base that results from the Fed
conducting an open market operation changes the supply
of money.

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Copyright © 2023 Pearson Education, Ltd.
 The Money Market

2. Target the Nominal Interest Rate

A change in the demand for money puts pressure on the
interest rate to change, so the Fed responds with an open
market operation to keep the interest rate on target
(2024/03/27: 5.25%~5.5%).
An increase in the demand for money is met with a Fed
open market purchase, which increases the quantity of
money supplied to prevent the interest rate from rising.
Similarly, a decrease in the demand for money is met with
a Fed open market sale, which decreases the quantity of
money supplied to prevent the interest rate from falling.

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 The Money Market

3. Target the Quantity of Money

A change in the demand for money puts pressure on the
quantity of money to change, so the Fed responds with an
open market operation to keep the quantity on target.
An increase in the demand for money is met with a Fed
open market sale that decreases the monetary base and
keeps the quantity of money on target.
Similarly, a decrease in the demand for money is met with
a Fed open market purchase that increases the monetary
base and keeps the quantity of money on target.

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 The Money Market

The Supply of Money

Figure 25.6 shows three
supply of money curves.
If the Fed targets the:
1. Monetary base, the supply
curve slopes upward.
2. Interest rate, the supply
curve horizontal.
3. Quantity of money, the
supply curve is vertical.
.
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 The Money Market

Money Market Equilibrium

Money market equilibrium
occurs when the quantity of
money demanded equals the
quantity of money supplied.
The adjustments that bring
money market equilibrium in
the short run depend on the
money supply regime.
The adjustments are
fundamentally different in the
short run and the long run.
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 The Money Market

If the interest rate is

4 percent a year, …
the quantity of money that
people are willing to hold is less
than the quantity supplied.
To get rid of the “excess”
money, people buy some
bonds. (excess money
reduces, the interest rate falls,
超額貨幣減少，隱含利率降低 ).
The interest rate falls (because
of the increasing bond price).
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 The Money Market
If the interest rate is
2 percent a year, …
the quantity of money that people
plan to hold exceeds the quantity
supplied. (Md>Ms) People try to
get more money by selling some
bonds ( 市場的資金不足，只好賣債券，大家
都在賣債券，債券價格下跌，隱含利率上升 ).
Pbond ( 債劵價格 ) ≈ (1/r) 與利率成反比
The interest rate rises.
Money market equilibrium occurs
at 3 percent a year and $20 trillion.

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 The Money Market

The Short-Run Effect of a

Change in the Quantity of
Money
Initially, the interest rate is
3 percent a year.
If the Fed increases the
supply of money, people will
be holding more money than
the quantity demanded. (at
3%, Ms>Md 多餘的錢只好去買債
券，造成債券價格上漲，隱含利率下
跌)
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 The Money Market

People buy bonds.

The increased demand for
bonds raises the bond price
and lowers the interest rate.

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 The Money Market

Initially, the interest rate is 3

percent a year.
If the Fed decreases the
supply of money, people will
be holding less money than
the quantity demanded.
They (Fed) sell bonds.
The increased supply of
bonds lowers the bond price
and raises the interest rate.

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 The Money Market

Long-Run Equilibrium
In the long run, the loanable funds market (Ms/P, Md )
determines the real interest rate.
Nominal interest rate equals the equilibrium real interest
rate plus the expected inflation rate.
Real GDP equals potential GDP ( 長期 !), so the only
variable left to adjust in the long run is the price level. ( 只剩
price 可變動 , Y, L, r, Ms/P 都不變 ) , r: real interest rate, i:
nominal interest rate
Remark: 充分就業 ( 古典學派的主張 ) ，總供給線 AS 是垂直

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Copyright © 2023 Pearson Education, Ltd.
 The Money Market

If in long-run equilibrium, the Fed increases the quantity of

money, the price level changes to move the money market
to a new long-run equilibrium.
In the long run, nothing real has changed.
Real GDP, employment, the real quantity of money, and
the real interest rate are unchanged.
In the long run, the price level is the only variable that is
free to respond to a change in the supply of money.
In the long run, the price level changes by the same
percentage as the change in the quantity of money. ( 這
理論說明 : 為什麼央行不能隨便印鈔票 )
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 The Quantity Theory of Money

The quantity theory of money is the proposition that, in

the long run, an increase in the quantity of money brings
an equal percentage increase in the price level.
The quantity theory of money is based on the velocity of
circulation ( 流通速度 ) and the equation of exchange ( 交易方程
式 ).
The velocity of circulation ( 流通速度 ) is the average number
of times in a year a dollar is used to purchase goods and
services in GDP

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 The Quantity Theory of Money

Calling the velocity of circulation V, the price level P, real

GDP Y, and the quantity of money M:
V = PY ÷ M.
The equation of exchange states that
MV = PY; P=M(V/Y).
The equation of exchange becomes the quantity theory of
money if M does not influence V or Y.
So in the long run, the change in P is proportional to
the change in M.

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 The Quantity Theory of Money

Expressing the equation of exchange in growth rates:

(Money growth rate + Rate of velocity change) = (Inflation rate +Real GDP
growth)

Rearranging:
Inflation rate = (Money growth rate + Rate of velocity change
− Real GDP growth)
In the long run, velocity does not change, so
Inflation rate = Money growth rate − Real GDP growth ( 想
一想日本央行的貨幣政策 )

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 Math Note: The Money Multiplier

To see how the process of money creation works,

suppose that the desired reserve ratio is 10 percent and
the currency drain ratio is (C/D=) 50 percent. (1/3
cash 、 2/3 deposit)
The process starts when all banks have zero excess
reserves and the Fed increases the monetary base by
$100,000.
The figure in the next slide illustrates the process and
keeps track of the numbers.

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 Math Note: The Money Multiplier

The bank with excess

reserves of $100,000
loans them.
Of the amount loaned,
$33,333 drains from the
bank as currency (1/3)
and $66,667 remains
on deposit (2/3).
Currency drain is 50
percent of deposits.

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 Math Note: The Money Multiplier

The bank’s reserves

and deposits have
increased by $66,667,
so the bank keeps
$6,667 (10 percent of
deposits) as reserves
and loans out $60,000.

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 Math Note: The Money Multiplier

$20,000 drains off as

currency and $40,000
remains on deposit.
Again, the currency
drain is 50 percent of
deposits.

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 Math Note: The Money Multiplier

The process repeats

until the banks have
created enough
deposits to eliminate
the excess reserves.
The $100,000
increase in monetary
base has created
$250,000 of money.

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 Math Note: The Money Multiplier

The size of the money multiplier depends on

< The currency drain ratio (C/D)
< The desired reserve ratio (R/D)
Money multiplier = (1 + C/D)/(R/D + C/D)
In our example, C/D is 0.5 and R/D is 0.1, so
Money multiplier = (1 + 0.5)/(0.1 + 0.5)
= (1.5)/(0.6)
= 2.5

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