Econ - impact of price level and inflation on money demand impact, question, demand, opposite, linked

whew1110

Hi all

I have a question on demand for nominal money

I read that :
when price level goes up, then demand for nom money goes up. I need more money to buy goods
when inflation rate goes up, then nominal int rate goes up, demand for nom money goes down. I prefer not to hold money

but for me price level and inflation are linked (if not the same) so how can they have opposite effect on demand for money

little confused here...

tks for your help

Finalnub

According to my notes, demand for nominal money is affected by 3 things:

1. Price Level
2. Interest Rates
3. Financial Innovation

Inflation isn't explicitly listed as one of the factors affecting demand. However, you can look at it like this. If inflation goes up that means REAL interest rates have gone down. If real interest rates are down, I'm more inclined to borrow because the opportunity cost of holding money is also down. In that sense demand for nominal money actually goes up when there's inflation. That's just my theory I haven't really looked it over but that's how I've always understood it.

ishfaque

as i understand when inflation rate goes up, then nominal int rate goes up, demand for real (not nom) money goes down. and real demand goes down since you prefer to hold high-yielding assets rather than low yielding M1. in fact by the qty theory, inflation is concurrent with nominal money growth so inflation up should lead to more qty of nominal money.

FVPV

bben Wrote:
-------------------------------------------------------

> but for me price level and inflation are linked
> (if not the same) so how can they have opposite
> effect on demand for money
>



inflation and price level are NOT the same. inflation is a persistent increase in price level. the price level can increase, but not persistently increase. big difference.

increase in price level will lead to more money demanded - things cost more.

with high inflation the nominal rate increases, hence the cost of holding money increases so investors will demand less by investing excess cash to earn the higher rates.

inflation is longer term, price level can jump up and then back down.



Edited 1 time(s). Last edit at Thursday, November 18, 2010 at 10:42PM by BayStreet.

mnieman

Tks guys for your explanations, it's clear now