1. Role of money in the economy
chapter 14
Capital, return and interest
Real economy
Self- sufficient household (economy) – production and consumption
Investment and savings
Investment, production, savings and return
Investment, production, savings, return and the real (natural) interest rate
1
2. The determination of interest in a capital market
Supply of capital
(Savings)
2
Return
Qc
Demand for capital
(Investment)
r2
r1
3. The determination of interest in the gold market
Determination of interest rate in a commodity money system
3
Interest
Qm
Demand for gold money
i2
i1
Supply of gold money
4. Determination of interest in a fiat money system
4
Interest
Qm
Demand for fiat money
i2
i1
Supply of fiat money without a
central bank
5. The determination of interest in the fiat money market
Determination of interest rate in a fiat money system with-out and with a central
bank
5
Interest
Qm
Demand for fiat money
i2
i1
Supply of fiat money with a central bank
6. Financial prices connect money and real capital
markets: The determination of the price of a bond market
Demand of bonds
(Save - money exchanged for bonds)
6
1/P
Qb
Supply of bonds
(Investment – bonds exchanged for money
1/P*
1/P
7. Relation between markets and the: return on capital, price of capital and
money interest rate
• MV=PY where M= money stock; V= velocity of money; P=money as medium of account
and Y= stock of products (production)
and M=1/v[PY] where 1/v=k and k = demand for money
and MV/P = Y where MV/P is use of real money use and Y is Real Income = Real Production
• i = R = r/P where i=real rate of money interest; r=real return = [P*- P] and P= price of
asset (good/bond) [ix100 = r/Px100 to make it possible to relate interest value and return
index – return is relative value – depends on the price of an asset].
• Arbitration, speculation and market equilibrium
7
8. Simultaneous equilibrium in the capital, financial and money market
Capital market Money market Financial market
8
I S
Sb [demand
for money]
Lm Ms
QmQb
i=R[=r/p]
↓
Qc
1/p [= i/r]
Market for
maize seed
Market for
money
Market for
bonds
↓ ↓
Db [supply of
money]
i
i*
i[=r/p]