Aggregate Money Demand

Running Head: Aggregate Money Demand
Aggregate Money Demand
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11 May 2011
Outline
* Introduction
* Components of Aggregate Money Demand
* Factors Affecting Aggregate Money Demand
* Measuring Money Demand
* Conclusion
* References
* Appendix
Introduction
Aggregate money demand is simply the demand for money in the economy which comes from the two basic units of economies- i.e. households and firms. The demand for money is an important aspect for economists as it helps measure the stability of an economy and is also an important factor in determining government intervention policies.
More specifically, in the recent past, with the on set of the financial crisis, the world experienced some of the worst liquidity problems as the aggregate demand for money rose beyond imagination. When BNP Paribas declared that its investors could not withdraw funds from two of its hedge funds due to subprime losses and shortage in cash, people with investments in other institutions also realized that the same thing could happen to them. As a result many investors and depositors started demanding their money back, where aggregate money demand rose to alarming levels, much beyond the cash reserves that these banks had. CITATION BBC09 \l 1033 (BBC, 2009) As a results one of the banks, Northwestern Rock faced the largest run on by depositors who were seeking their money back. As money demand rose, the banks were unable to meet these requirements and the government had to step in as guarantor.
Even if such events are the stuff of nightmare, and are fortunately a rare event, aggregate money demand, knowing how it works, and what are the factors affecting it is important for economists and policy makers to understand in order to formulate effective policies to balance the economy.
Before the paper proceeds to analyze the demand for money, it is important to define what money is. There are basically two types of money, Currency- which includes notes and coins in circulation, and checkable deposits on which account holders can write checks and these too function as money as they are immediately effective in giving the owner the right to purchase.
Components of Aggregate Money Demand
The three components of aggregate money demand are derived from the functions that money serves as a medium of exchange and as a store of value. These three components are demand for transactions balances, the demand for speculative balances and finally the demand for precautionary balances. These three demands are the components of the aggregate demand for money, discussing each in turn will help understand the functions of money better and will also help understand the reasons for the various fluctuations in money demand. CITATION Jer02 \l 1033 (Mushin, 2002)
With regards to the demand for transaction balances, these balances are the money held in hand in order to make cash payments. These are held in hand to deal with the demand for paying money when there is a timing lag between payments and receipts. The transactional balance that is kept at hand is directly related to the income of the firms and households, as the more income th...