Asset Market Equilibrium

Macroeconomic Theory I

ECON222

Fall 2017

Macroeconomic Theory I (ECON222) Money & Asset Markets Fall 2017 1/6
Asset market equilibrium

The asset market is in equilibrium when the demand for each asset
equals the available supply

We simplify by assuming that all assets may be grouped into

monetary and nonmonetary assets

Asset market equilibrium ) the quantity of money supplied equals

the quantity of money demanded:
M
= L(Y , r + e )
P

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 Figure: Asset Market Equilibrium

Macroeconomic Theory I (ECON222) Money & Asset Markets Fall 2017 3/6
 Figure: Increase in the Money Supply, M

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Long run implications

The asset market equilibrium condition is:

M
= L(Y , r + e )
P

In the long-run, this eectively determines the price level:

M
P=
L(Y , r + e )

,! M is determined by the central bank

,! In the long-run, Y and r are determined by equilibrium conditions in
labour and goods markets
,! expected ination, e , is taken as given

Macroeconomic Theory I (ECON222) Money & Asset Markets Fall 2017 5/6
Money growth and ination in the long run
Ination equals nominal money supply growth minus real money
demand growth:
P M L(Y , r + e )
=
P M L(Y , r + e )
,! ination is closely related to nominal money supply growth

In the long-run with constant money growth, the nominal interest

rate will also be constant

The rate of ination in a full-employment economy also depends on

real income growth and the income elasticity of money demand ( Y ):

M Y
= Y
M Y

Macroeconomic Theory I (ECON222) Money & Asset Markets Fall 2017 6/6