In Chapters 3 and 4 we discussed the labor market and the goods market, two of the three markets in our model of the macroeconomy.
In this chapter we consider the third market, the asset market. By asset market we mean the entire set of markets in which people buy and sell real and financial assets, including, for example, gold, houses, stocks, and bonds.
A type of asset that has long been believed to have special macroeconomic significance is money. Money is the economist's term for assets that can be used in making payments, such as cash and checking accounts. One reason that money is important is that most prices are expressed in units of money, such as dollars, yen, and euros. Because prices are measured in money terms, understanding the role of money in the economy is basic to studying issues related to the price level, such as inflation and its causes. In addition, many economists believe that the amount of money in the economy affects real economic variables, such as output and employment. If it does, then it may be possible to use monetary policy to promote stable output growth and fight unemployment, as we discuss in Part 3.
Because money is such an important asset, it is the focus of our discussion of the asset market. In the first part of the chapter we explain what money is and why people choose to hold it. We show that a person's decision about how much money to hold (their money demand) is part of a broader decision about how to allocate wealth among the various assets that are available. We then bring together the demand for money and the supply of money (which is determined by the central bank) to analyze equilibrium in the asset market. This analysis demonstrates that the price level in an economy is closely related to the amount of money in the economy. Thus high rates of inflation—that is, rapid increases in prices—are likely when the money supply is growing rapidly.
Learning Objectives
7.1 Define money, discuss its functions, and describe how it is measured in the United States.
7.2 Discuss the factors that affect how people choose which assets they own.
7.3 Examine macroeconomic variables that affect the demand for money.
7.4 Discuss the fundamentals of asset market equilibrium.
7.5 Discuss the relationship between money growth and inflation.
7.1