Wealth creation

1
Wealth creation

• Holding money (M1)
• at Zero interest

2
If nominal GDP is 300, at zero interest, and
every dollar of income is spent by definition
M1 should be 300 and velocity will be one
PQ
10
7.5
Interest Rate
5
2.5
Transaction Demand
100
50
150
200
250
300
Quantity of (M1) money demanded
3
Wealth

• Generally, wealth is considered the accumulation
  of productive resources (the ownership of the
  means of production) to quote Marx.
• Productive resources generate income
• Money is not a productive resource, it produces
  zero income
• So why hold some of my wealth as money?

4
Holding money as wealthsome of the functions and
characteristics of m1 at play

• Money (m1) has a store of value
• Money (m1) is fungible
• A 50 note today is a 50 note next year
• Therefore there is no risk in holding on to the
  50 note
• Therefore money is perfectly liquid there is no
  transaction cost in making, the 50 you held,
  available for a transaction next year

5
So, why hold (save) wealth as money?

• Even if it generates no income- always paying
  zero interest??
• Money is an attractive asset to be holding when
  the prices of goods services or other financial
  assets
• are expected to decline
• This is speculative asset demand
• Money is an attractive asset to be holding when
  income unexpectedly declines
• This is precautionary asset demand

6
Whats all this about zero interest?

• What determines the interest rate?
• That is found in the Loanable funds market and is
  affected by the profit motive
• While the demand for loans may be infinite at
  zero cost to borrowers for
• new physical capital
• research and development
• education
• cars
• trips
• No one is willing or able to supply the money for
  a loan, if no one is willing or able to pay for it

7
Why is zero interest important?

• At zero interest, there is no opportunity cost to
  holding money (m1) as an asset (holding money as
  wealth)
• So its back to our original graph and the formula
  MVPQ
• Or PQ/MV

8
If nominal GDP is 300, at zero interest, keeping
output constant and every dollar of income is not
spent but 50 is held as asset demand (either
precautionary or speculative) by definition M1
for transactions should be 250 and velocity will
be 1.2the 250 has to work harder (move more
quickly through the economy) in the same time
period but the quantity of M1 demanded is still
300
PQ
10
7.5
Interest Rate
5
2.5
Asset demand
Transaction Demand
100
50
150
200
250
300
Quantity of (M1) money demanded
9
If nominal GDP is 300, at zero interest, keeping
output constant and every dollar of income is not
spent but 100 is held as asset demand (either
precautionary or speculative) by definition M1
for transactions should be 200 and velocity will
be 1.5the 200 has to work harder (move more
quickly through the economy) in the same time
period but the quantity of M1 demanded is still
300
PQ
10
7.5
Interest Rate
5
2.5
Asset demand
Transaction Demand
100
50
150
200
250
300
Quantity of (M1) money demanded
10
If nominal GDP is 300, at zero interest, keeping
output constant and every dollar of income is not
spent but 150 is held as asset demand (either
precautionary or speculative) by definition M1
for transactions should be 150 and velocity will
be 2the 150 has to work harder (move more
quickly through the economy) in the same time
period but the quantity of M1 demanded is still
300
PQ
10
7.5
Interest Rate
5
2.5
Asset demand
Transaction Demand
100
50
150
200
250
300
Quantity of (M1) money demanded
11
If nominal GDP is 300, at zero interest, keeping
output constant and every dollar of income is not
spent but 200 is held as asset demand (either
precautionary or speculative) by definition M1
for transactions should be 100 and velocity will
be 3 -the 100 has to work harder (move more
quickly through the economy) in the same time
period but the quantity of M1 demanded is still
300
PQ
10
7.5
Interest Rate
5
2.5
Transaction Demand
Asset demand
100
50
150
200
250
300
Quantity of (M1) money demanded
12
Now let us hold the velocity and output constant
and let us add the interest rate!

• Suppose some are willing and able to pay interest
  in order to borrow
• The profit motive and opportunity cost take over
• The amount you are willing to hold at zero
  interest is reduced by the amount you are willing
  to risk and at the transaction cost of liquidity

13
If nominal GDP is 300, at 2.5 interest, keeping
output constant and every dollar of income is not
spent but 150 is held as asset demand (either
precautionary or speculative) and 50 is
deposited as M2,by definition M1 for transactions
should be 100 and velocity will be 3 -the 100
has to work harder (move more quickly through the
economy) in the same time period but the
quantity of M1 demanded is now 250
PQ
10
7.5
Asset demand
Asset demand
M2 savings
Interest Rate
5
2.5
Transaction Demand
Asset demand
100
50
150
200
250
300
Quantity of (M1) money demanded
14
If nominal GDP is 300, at 5 interest, keeping
output constant and every dollar of income is not
spent but 100 is held as asset demand (either
precautionary or speculative) and 100 is
deposited as M2,by definition M1 for transactions
should be 100 and velocity will be 3 -the 100
has to work harder (move more quickly through the
economy) in the same time period but the
quantity of M1 demanded is now 200
PQ
10
7.5
Asset demand
Asset demand
M2 savings
Interest Rate
5
2.5
Transaction Demand
Asset demand
100
50
150
200
250
300
Quantity of (M1) money demanded
15
If nominal GDP is 300, at 7.5 interest, keeping
output constant and every dollar of income is not
spent but 50 is held as asset demand (either
precautionary or speculative) and 150 is
deposited as M2,by definition M1 for transactions
should be 100 and velocity will be 3 -the 100
has to work harder (move more quickly through the
economy) in the same time period but the
quantity of M1 demanded is now 150
PQ
10
Asset demand
Asset demand
M2 savings
Interest Rate
7.5
5
2.5
Transaction Demand
Asset demand
100
50
150
200
250
300
Quantity of (M1) money demanded
16
If nominal GDP is 300, at 10 interest, keeping
output constant and every dollar of income is not
spent but 0 is held as asset demand (either
precautionary or speculative) and 200 is
deposited as M2,by definition M1 for
transactions should be 100 and velocity will be
3 -the 100 has to work harder (move more
quickly through the economy) in the same time
period but the quantity of M1 demanded is now
100
PQ
10
7.5
Asset demand
Asset demand
M2 savings
Interest Rate
5
2.5
Transaction Demand
100
50
150
200
250
300
Quantity of (M1) money demanded
17
Summation MVPQ

• The m in the formula is m1 for transactions only
• The v in the formula is the number of times in a
  year m1 for transactions is transferred through
  the economy
• The money supply always has to equal the combined
  transaction demand plus the asset demand for m1
• The amount of m1 held as an asset is inversely
  related to the interest rate

18
Some notes

• At zero interest, banks provide checking accounts
  on a fee basis
• When banks can make a profit, because people are
  willing to pay interest, and banks are willing to
  take risk, checking accounts are provided on a
  free basis - often with rewards (a free toaster,
  in my day, mileage or overdraft forgiveness in
  yours)
• M2 increases the money supply because (if)
• it is being recirculated as loans, within the
  economy
• And (if) when the loans are being deposited into
  banks