Topic 8: The Monetary Model

Question 1

How is the monetary model formed?

Answer 1

By combining absolute purchasing power parity and quantity theory.

Question 2

How is the quantity theory formed?

Answer 2

Demand: M_d = k.P.y

Supply: M_s = M (exogenous.)

Combined:

P = ^M/_ky

We assume M, k and y are exogenous.

Question 3

What are the endogenous variables in monetary theory?

Answer 3

• S(d/f)
• P

Question 4

What is the final monetary theory?

Answer 4

S(d/f) = P / P*

P = M/ky

We can express it as one equation. But we don’t.

Question 5

Show a graph that demonstrates equilibrium in the monetary model.

Answer 5

Question 6

Show the effects of an increase in money supply in the monetary model.

Answer 6

• Increase in M -> increase in P (from P₁ to P₂.)
• -> increase in S (from S₀ -> S₁)
• A depreciation
• Analyis:
• Rise in M causes price inflation via QT
• Rise in P causes reduce domestic competitiveness -> depreciation.

Question 7

What is the approximate equation from the MM model?

Answer 7

From QT:
%ΔP ~= %ΔM - %ΔY - %Δk,

(so)

%ΔP ~= %ΔM

From APPP:

%ΔS = %ΔP = %ΔM