Answer to Question #209972 in Finance for Louis Ag

Question

Question 4

a.discuss the main tenets of the quantity theory of money. (10marks)

b.what is the near money, also known as quasi-money? (4marks)

c.broad money is said to have benefits for decision makers. What benefits does the use or this measure provide? (6marks)

Question 5

a. The IS-LM curve model emphasizes the interaction between the goods and money markets .discuss in detail  (12marks)

b. What is meant by money market equilibrium in relation to the LM curve? (6marks)

c. What is meant by the term liquidity? (2marks)

Question 6

a. Discuss what qualitative and quantitative controls are in monetary policy. (8marks )

b. what role do interest rates play in the control of monetary policy. (6marks)

c.How does credit affect the money supply in an economy? (6marks)

Answer 1

Quantity theory of money States that money supply and price level in an economy are proportional such that when there is a change in money supply, there is a proportional change in price level.

Therefore the main tenets(belief) of the quantity money theory is that money supply and price level are proportional.

Near Money/ quasi money

This refers to the highly liquid assets that are easily convertible into cash.This helps in determining the level of liquidity.

Benefits of Broad money

Broad money is the most inclusive method of calculating a county's money supply.

• It widens the scope of the total money in circulation.
• It helps in setting monetary policy
• It has enabled economists establish the relationship existing between money supply, inflation and interest rates.
• It helps policy makers have a better grasp on potential inflationary trends
• Helps the central banks to know the interventions they can put in place to influence the economy.

IS-LM

IS shows relationship between production Y of goods with investment and government spending. The interest rate affects the investment such that higher interest rates make investments more expensive. Consequentially, production becomes expensive because there will be less investment into production.

LM represents the relationship between liquidity and money. Interest rate is determined by the equilibrium of supply and demand for money.

M/P = L( i,Y)

i = real interest rate

Y = Real income

L = demand of money

From the above explanation, we clearly see the relationship between money and goods. That is , when equilibrium created by money supply and money demanded, interest rates are obtained that influences the cost of production of goods.

Money market equilibrium

This is a state when IS curve and LM curve are equal.At this point the real interest rate is determined.However, change in government spending increases productivity at any interest rate. This causes a shift in the IS curve and therefore equilibrium shifts consequently the real interest rate and level of production Y changes as shown below.

increase in the money supply causes a shift in the LM curve as illustrated below.

Liquidity

This is the ease at which assets or security can readily be converted into cash.

Qualitative Methods

they are the selective instruments used for determining between various uses of credit. For example, the favouring of exports over imports. They include;

• Rationing of credit
• Regulation of consumer Credit
• Moral Suasion
• Change in marginal requirement

Quantitative Methods

Known as the general tools used by the central banks. They are related to the quantity and volume of money.

They are;

• Bank Rate Policy
• Legal Reserve Ratios
• Open Market Operations
• Repo rate
• Reverse Repo rate.

what role do interest rates play in the control of monetary policy

During contraction phase of the business cycle, interest rates are increased and this significantly reduces inflation and economic activity. Therefore increased interest rates reduces the money supply in the economy since people will want to bank more money. Decreased interest rate makes the government spend more buying public amenities therefore inflation rises.

Role of credit in money supply

When interest rates are low the banks give credit to the public since the interest accrued will not be much and secondly, the public is not willing to bank their money in the banks.

This happens when the money supply to the economy is low. This therefore is normally a measure to ensure there is money circulation in the economy.