Revision Notes: The Revival of the Quantity Theory (Friedman & the ‘Chicago School’)

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-         Relationship between Δs in MS & resulting Δs in money nat inc held to be much more predictable than K’n; & liquidity trap case (whereby Δ in MS exerts no effects) explicitly denied.

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Friedman: Δs

in Money volume may Δ output, employment & i. rates in ST, in LT,

these variables will approach ‘natural’ levels indep of money volume.

Friedman View of Money Demand: (revised Q. theory) there is a stable MD

function i.e. MD varies fairly predictably if Δs in a few key variables:

most important elements influencing MD:

1.      Rates of Return on Money & other Assets (real & financial).

2.      The Level of Permanent Income.

3.      The Ratio of non-human to total wealth.

Demand for Real Money Holdings: M f ( rm, rb, Pe, Y, w, u)

P

where:

rm expected nominal rate of return for money

zero for cash, but +ve or ve for bank deposits (interest and service

charges)

rb expected nominal rate of return on bonds (including expected changes in their prices)

re expected nominal rate of return on equities (including expected Δs in their Ps)

Pe expected rate of changes of prices

Y permanent income (an index of total wealth)

w %age of total wealth held in non-human form & thereby readily realisable (e.g. as property holdings)

u all other influences which may determine preference patterns generally.

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An increase in

expectations of inflation would normally produce a decline in MD that is, a

rise in velocity.

-        

(so diff. to trad

quantity theory which assumes constant velocity velocity will change in predictable

way)

 

Keynesian Position: money demand unstable

Traditional Q. Theory Position: money demand comparatively stable

Modern Quantity Theory Position: Straddle both positions increase in Q of

money will accordingly generate a general increase in demand for commodities

and also exert an impact on interest rates.

Belief that money demand generally insensitive

to changes in the i. rate crucial to modern q. theory. Implicit in this contention is notion that transactions

motive dominates the asset motive in total money demand.

 

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