Transcription
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The demand for money is the amount of money held by individuals and businesses in liquid form, i.e., directly spendable at an individual level. People want to hold money for transaction purposes, i.e., to make daily purchases.
For precautionary purposes, i.e., to be able to meet the expected costs or to make an investment that presents an advantageous interest, in both cases, a determining weight is assumed by the interest rate. The interest rate represents the opportunity cost of holding cash rather than making it profitable with an investment.
It can therefore be considered the price of money. Similarly to what happens with the law of demand for goods and services, there is an inversely proportional relationship between the interest rate and the demand for money. The more the interest rate increases, the more individuals are attracted to investments and less motivated to hold coins in liquid form.
Therefore, the demand for money decreases as the interest rate increases. We represent what we have said in a Cartesian graph by placing the quantity of money demanded on the x-axis and the interest rate on the y-axis. At the interest rate t1, the money demand will be equal to m1.
If the interest rate increases from 1 to 2, the demand for money decreases from m1 to m2. From this, we can deduce that the lower the interest rate, the greater the demand for money will be; vice versa, the higher the interest rate, the lower the demand for money.
The supply of money is the quantity of money in circulation in a country at a given time and is made up of the sum of the currency in circulation and the bank account deposits. The money supply is influenced by the policies of the central bank of each country.
In the countries of the Eurozone, including Italy, the money supply is influenced by the European Central Bank (ECB). Before the introduction of the euro in Italy, the money supply was influenced by the Bank of Italy.
Graphically, the money supply can be represented as a perfectly vertical line corresponding to a certain quantity of money m asterisk at the rate level i1 and i2. As we can see, the money supply is always equal to m asterisk.
If we go to represent the two curves on the same graph, we can notice that they intersect at the point, and in correspondence with this point, we get the level of the equilibrium interest rate measured by the segment or asterisk. This is the level of interest rate at which the demand and supply of money are equal, bringing the system into equilibrium.