I am trying to roughly sketch up supply / demand curves by parameterizing the major happenings in the money market in 2020. I intend to use this chart as the template:
Below, I'll outline my thought process for each curve:
- Interest rate targeted at zero
- Fed balance sheet expands (a lot)
Graph implication: money demand curve(straight line) shifts to the right
This is the tricky part, as money demand is not something we can directly observe in practice, though I tried my best to be objective/conservative.
Unemployment spikes in April, then slowly stabilizes around 6% in 3Q20
Total income probably drops off a cliff for a few months and slowly revives with industries streamlining / automating / outsourcing, setting a lower total income floor than pre-pandemic times
Stimulus / helicopter money offsets deflationary forces
Risk-off sentiment during March's downturn drives defensive portfolio positioning, increasing demand for cash
BofA September poll: fund manager consensus that it's a new bull market, investors rotate out of cash/equivalents and into higher yielding assets, reducing demand for cash
Graph implication: Money demand undergoes a short-term shift to the right, but trends to a shift to the left from a likely permanent contraction in total income and the onset of a new bull market (admittedly not a slow bull)
Conclusion: I realize there are multiple factors at play here, but I think it's reasonable to assert that, on balance, the demand curve shifts left and the supply curve shifts right.
And thus I present my rough sketch of the money market:
Is this parameterization consistent with mainstream economic analysis on the money market in 2020?