Economics
Keynesian Demand for Money
Keynesian demand for money refers to the amount of money people want to hold for transactions and precautionary purposes. According to Keynesian economics, this demand is influenced by income and interest rates. As income rises, the demand for money also increases, while higher interest rates reduce the demand for money as people opt for alternative assets.
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11 Key excerpts on "Keynesian Demand for Money"
eBook - ePub- Rousseas(Author)
- 2016(Publication Date)
- Routledge(Publisher)
CHAPTER 3 The demand for money and the rate of interestThe exogenous money supply
Within traditional Keynesian economics money serves as a means of payment and a store of wealth. These two functions of money were used by Keynes to undermine the classical dichotomy between the real and monetary sectors of the economy. The end result was his liquidity preference theory of the demand for money which allowed changes in the monetary sector to be transmitted to the real sector through changes in the rate of interest. But Keynes also assumed, along with everyone else, that the supply of money was exogenously determined. An exogenous money supply is simply another way of saying that the central bank (through its use of open market operations, the discount rate, and reserve requirements) can adjust the overall volume of money, in response to changes in the demand for it, to that level consistent with its policy objectives.In a tight money situation, neoclassical Keynesian analysis, as we shall see, did allow that certain short-run leakages could occur, via changes in the income velocity of money in response to interest-rate changes, that would tend to undermine the effectiveness of a monetary policy operating directly on the supply side. Such leakages, however, were believed to play themselves out quickly, allowing the full effectiveness of monetary policy to take hold in sufficient time to achieve the policy objectives of the monetary authorities. Monetarists, on the other hand, deny that the central bank can effectively use discretionary monetary policy in the short run. The variable lags of monetary policy, in conjunction with the inability of anyone to locate the actual position of the economy on the business cycle, at any particular moment of time, make it impossible, according to the monetarists, for the central bank to control the exogenous money supply in a contracyclical manner. Indeed, central bank policies are notoriously perverse in achieving ex post what was not intended. For monetarists the only sensible thing to do is to ignore the short-run business cycle altogether and play for the long run. The greatest contribution the central bank can make, in their view, is to allow the money supply (which is presumed to have a stable relationship to the monetary base, i.e., the sum of bank reserves and currency in circulation) to increase mechanically at the natural, long-term growth rate of the economy adjusted for the secular decline in the income velocity of money—the famous "monetary rule." But whether one opts for the monetarist rule or the Keynesian use of short-run discretionary monetary policy with the rate of interest as its target, the fact remains that both
eBook - PDF- Subrata Ghatak, José R. Sánchez-Fung(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
Before M f any increase in money supply, for example, 0 M 1 to 0 M 2 raises production from M 1 Q 1 to M 2 Q 2 . Beyond full employment, a rise in money supply from 0 M 3 to 0 M 4 simply bids up the prices to P 1 and P 2 as has been indicated by the price line. The interest rate is, however, determined in the money market, and this will be discussed next. 5.3 Money and the interest rate ..................................................................................... In the Keynesian model, the rate of interest r is determined by the demand for money M d and supply of money M s . Money supply is usually treated as fixed in the short .................................................................. 72 Monetary economics in developing countries run, and as such M s is invariant to changes in r . This is shown by S 1 S 1 in Figure 5.5. The demand for money (or M d ) consists of three parts: (a) transaction demand for money; that is, M 1 ; (b) precautionary demand for money, that is, M p ; and (c) speculative demand for money, that is, M s p . Thus we have M d = M t + M p + M sp (5.17) The demand for money for day-to-day transaction purposes usually depends on the level of income, or Y . The precautionary demand for money also depends on Y , and it stems from the necessity to hold cash balances for ‘rainy days’. The specu-lative demand for money is the real Keynesian invention. If money could be regarded as a financial asset in the portfolio, then such an asset could be held in the port-folio along with ‘other’ assets. Keynes lumped these ‘other’ assets together and called them ‘bonds’. People may wish to hold ‘bonds’ rather than liquid money because interest is paid to the bondholders. Bond prices could change, and thus bond-holding involves some risks. Also, different rates of interest are paid on different bonds. The average of such interest rates may be regarded as ‘the’ interest on bonds.
eBook - PDFMonetary Economics
Theories, Evidence and Policy
- David G. Pierce, Peter J. Tysome(Authors)
- 2014(Publication Date)
- Butterworth-Heinemann(Publisher)
We have now looked at each of Keynes' three motives for holding money. The amount of money for the transactions and precautionary motives he denoted by the symbol the amount held for the speculative motive by M2. Corresponding to this division there are two liquidity functions Li and L2. Li depends mainly on the level of income, L2 mainly on the rate of interest and expectations. Thus: Μ = Ml + Λί2 = L i ( y ) + L2 (0 Keynes' analysis of the demand for money is clearly, therefore, divided into two parts, one part approaching money simply as a means of payment, the other as an asset. Individuals, according to this view, are seen to hold some money for transactions purposes and some for its use as a store of wealth. According to Johnson (1962, p. 90) this approach is a rather awkward hybrid of two theoretically inconsistent approaches, with the transactions demand being regarded as technologically determined, and the assets demand being treated as a matter of economic choice. Post-Keynesian developments 53 Certainly most post-Keynesian writing has attempted to aggregate the demand for money rather than continue the Keynesian distinction. The significant innovation of Keynes' analysis was to show that the demand for money was interest-elastic and that at some low rate of interest it might become perfectly so. The rationale for this was the existence of a speculative motive based on the existence of a gap between what individual speculators regard as the normal level of the rate of interest and the actual current level. There have, however, been several criticisms of these views. For example, it has been suggested that the gap between the normal and current interest rates would disappear as investors learned from experience. Any rate, if it persists long enough, will come to be accepted as normal. In equilibrium the demand for money for the speculative motive would be zero.
eBook - PDFFinance Constraints and the Theory of Money
Selected Papers
- S. C. Tsiang, Meir Kohn(Authors)
- 2014(Publication Date)
- Academic Press(Publisher)
Ohlin suggested that the demand for credit (or finance) for the ex ante investment could be met by the supply of credit provided by ex ante savings. Unfortunately, in order to make the concept of ex ante savings symmetric to the concept of ex ante investment, Ohlin and his Swedish colleagues defined the former as planned savings out of incomes that are expected to accrue in the future. But how could savings yet to materialize at some future date provide the ready finance currently needed by the investors? Keynes was certainly right in saying that the supply of finance must come out of existing cash balances or banks' credit creation. So after all, the interest rate must still be determined by the demand for liquidity (of money), including the newly recognized demand for finance, and the supply of liquidity, including new liquidity created by banks. Thus, a forced concession was turned into at least a partial victory. Actually, in a monetary economy, where loans are perforce given and taken in money, it should not make much difference to say that the rate of interest (i.e., the price of loans) is determined by the supply and demand for loans, or that it is determined by the supply and demand for money, in which these loans are given and taken. The crucial question is how one formulates or specifies the function of the demand for money, and what kind of answers one would get to certain specific questions, such as whether an increase in planned investment, or a decline in the propensity to save, would have a direct impact in raising the rate of interest given the supply of money. In the General Theory, Keynes merely allowed the value of income, or output produced Y and the rate of interest r as the main arguments of the demand for money function (or functions, as Keynes in the General Theory formulated the demand for money in two separate functions, M d = L{Y) + L 2 (r)).
- Gang Yi(Author)
- 2019(Publication Date)
- Routledge(Publisher)
Under such circumstances the traditional theory of demand for money, such as the transactions and precautionary demand for money, are still relevant. A typical consumer faces a decision of how to allocate his wealth between money and consumer goods. Transaction demand for money is a function of income, and precautionary demand is a function of interest rate or some other measures of the opportunity cost of holding money. The fact that money is the only financial asset does not spoil the analysis as long as people have consumer goods as an alternative. The lack of financial securities becomes problematic when consumer goods are not available and there are forced savings. During the reform, more and more financial securities and real investment opportunities became available. The connotation of demand for money in China is getting closer to the standard definition in the West. The Demand for Money 157 Is There A Monetary Overhang in China'f Feltenstein and Ha (1991) have estimated the extent to which the price level was repressed in China and have shown that the decline in observed income velocity of money was due to involuntary savings by households. They constructed a true price index, by which they were able to demon-strate that the true velocity of money is statistically constant. By the end of 1988 the true price index was 114 percent higher than the official index, assuming that the two were equal at the beginning of 1979. They concluded that there was a monetary overhang in China in the sense that excess money was being held by households over the nominal value of trans-actions. Consequently there was repressed inflation and forced saving. The results derived by Feltenstein and Ha are not surprising except that the fact that the monetization factor is not significant in their paper. If we do not believe the official price index, and postulate that the true price is higher, we would get similar results.
eBook - PDF- Robert E. Lucas Jr., Max Gillman, Robert E. Lucas, Jr., Robert E Lucas, Max Gillman(Authors)
- 2013(Publication Date)
- Harvard University Press(Publisher)
This alteration introduces a Keynesian “liquidity preference” element into money demand that is entirely absent from the formulation I have sketched. Cochrane (1988) appears to have identified these liquidity effects, for peri-ods up to a year, in post-1979 U.S. weekly series on Treasury bill rates and money growth rates. (I say “appears” because the connections between theoretical models of the Grossman-Weiss-Rotemberg type and the esti-mation methods used by Cochrane have not been worked out in any detail.) 7. It is a perennial subject of debate among monetary economists whether there are ad-vantages to being as explicit about the nature of transactions demand as I have been here, as opposed simply to including real balances as a “good” in agents’ utility functions. I do not wish to be doctrinaire about this issue, but surely it cannot be wrong for monetary theorists to think about what people do with the money they hold. Economists who study the demand for coffee do not hesitate to use common knowledge about what people do with coffee, and this knowledge leads them to empirically useful ideas about what goods are likely to be close substitutes or complements for coffee, and hence what prices are likely to be useful in coffee demand functions. Why should those who study money demand not do the same thing? I found Tables 1 and 2 in Mankiw and Summers (1986) of great interest, and of evident use in guiding these authors’ thinking about money demand. Researchers confined to thinking of money simply as something people like to hold, without asking why they like to hold it, would never have been led to seek out, display and utilize these data. 11 n Money Demand in the United States: A Quantitative Review 263 By using annual data, it seemed possible that Meltzer’s results and mine might avoid contamination from these “liquidity preference” effects. We will see in the next section, however, that this hope is not confirmed, at least for post-1958 data.
eBook - PDF- R. Dimand, R. Mundell, A. Vercelli, R. Dimand, R. Mundell, A. Vercelli(Authors)
- 2010(Publication Date)
- Palgrave Macmillan(Publisher)
Keynes, in The General Theory, was the first to write money demand explicitly as a function of income and the interest rate. Irving Fisher had, in The Theory of Interest in 1930 (Fisher 1997, Vol. 9, 216), given what would now be considered a correct statement of the marginal opportunity cost of holding money, but had not stated the money demand function. Fisher had mentioned in passing the rate of interest as an influence on the velocity of circulation in 1896 in an article on the meaning of capital (Fisher 1997, Vol. 1), but not when systematically catalogu- ing determinants of velocity in The Purchasing Power of Money in 1911 (Fisher 1997, Vol. 4), even though just four years before he had written a book entitled The Rate of Interest. Passing mentions in verbal discussions, also common in Cambridge monetary theory before The General Theory, are no substitute for including a variable in a formal analysis. It is sig- nificant that Hawtrey should regard including the interest rate in the money demand function as something new and important contributed by Keynes. Hawtrey was one of the shapers of the “Treasury view” that public works spending would only crowd out private investment (see Hawtrey’s 1925 article reprinted in Dimand 2002b, Vol. 2), and so he has been interpreted, notably by Samuelson (1946) and Klein (1947), as implicitly believing in a classical vertical aggregate supply curve. This, Robert W. Dimand 303 however, would make nonsense of Hawtrey’s emphatic belief in the effectiveness of monetary policy. Furthermore, Hawtrey helped develop the finite-valued spending multiplier, providing a numerical example with leakage into imports alone in a 1928 Treasury memorandum, a numerical example with leakage into saving in a 1930 Macmillan Com- mittee working paper commenting on Keynes’s Treatise, and an algebraic version in 1932 (Hawtrey 1932, Dimand 1988, Deutscher 1990, Eric Davis 1990).
eBook - PDF- Robert J. Barro; Angus C. Chu; Guido Cozzi, Robert Barro, Angus Chu, Guido Cozzi(Authors)
- 2017(Publication Date)
- Cengage Learning EMEA(Publisher)
Therefore, at least if we neglect financial innovations, the real quantity of money demanded, D ( Y , i ), will be changing only because of the growth of real GDP, Y . 8 With economies of scale in money demand, the real quantity of money demanded would grow at a slower rate than real GDP. As discussed before, the empirical evidence suggests that these economies of scale are important for checkable deposits but not for currency. We are also neglecting the possibility that continuing financial innovations affect the real demand for money. Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 209 Chapter 11 The demand for money and the price level Seasonal variations in money We have argued that, to achieve price-level stability, the monetary authority has to vary the nominal quantity of money, M , to match the changes in the real quantity demanded, D ( Y , i ), that occur because of economic growth or fluctuations. An analogous argument applies to the variations in D ( Y , i ) associated with the seasons. Because the US dollar, being the dominant international reserve currency, has experienced a significant change in its seasonal variations, we discuss the US dollar currency here. Until the mid-1980s, the quantity of real currency held in December was about 2.6% higher than the average for the year, whereas the amount held in February was about 1.7% lower than average. If the monetary authority had kept the nominal quantity of currency, M , constant over the year, the price level, P , would have had the reverse seasonal pattern – low in December and high in February.
eBook - PDF- Sidney Weintraub(Author)
- 2016(Publication Date)
1 5 An Economics of Keynes'' Perspective on Money* HYMAN P. MINSKY Introduction Through the 1960s, and into the early 1970s, a monetarist counter-revolution swept through maeroeconomic theory in the United States. Monetarism is a version of the quantity theory of money, an adaptation which differs from the older forms in that it explicitly substitutes the stability of a demand function for money for the stability of the veloc-ity parameter implicit in the older formulations of the quantity theory. 1 In truth, monetarism is based upon errors of understanding as to what neoclassical theory proves and on errors of specification about the institutional characteristics of the economy in which we happen to live. 2 The transitory success that monetarism achieved among politi-*The title, distinguishing between the Economics of Keynes and Keynesian eco-nomics, is due to Axel Leijonhufvud. Despite differences I owe much to my colleagues in dissent from conventional wisdom: Paul Davidson, Sidney Weintraub, Victoria Chick, Jan Kregal, Robert Clower, and Axel Leijonhufvud, among Americans, and Joan Robinson, Lord Kahn, and Lord Kaldor in England. 'Milton Friedman, The Quantity Theory of Money—A Restatement, in Studies in the Quantity Theory of Money, ed. M. Friedman (Chicago: University of Chicago Press, 1956). 2 Frank Hahn, in his review [Economica 38, no. 149 (February 1971): 62-80] of Milton Friedman's book The Optimum Quantity of Money and Other Essays (Chicago: Aldine Publishing, 1969) is quite explicit on the lack of understanding of general equilibrium theory that permeates Friedman's work. 295 296 HYMAN P. MINSKY cians, pundits, and central bankers was mainly because the standard macroeconomic monetary analysis was superficial and error-ridden, not because of the logical or empirical case made for monetarism.
eBook - PDFIndia's Economic Prospects - A Macroeconomic And Econometric Analysis
A Macroeconomic and Econometric Analysis
- Thampy Mammen(Author)
- 1999(Publication Date)
- World Scientific(Publisher)
The results also indicate that the effect of the deficit on the monetary base cannot be offset by any feasible changes in the monetary tools considered in the model; viz., the bank rate and SLR. We are, therefore, postulating a model more in sympathy with the post-Keynesian endogeneity argument, which seems to be valid for the Indian economy. 6.4. Estimates of the Monetary Sector Demand Function for Money A. Demand for money Currency forms the major portion of the narrowly defined stock of money in India. We, therefore, present two separate demand functions for currency (C) and demand deposits (D). (6.1) C = Stock of currency with the public GDP = Nominal Gross Domestic Product RB = Short rate of interest represented by the inter-bank borrowing rate. Z9093 = 1 for the years 1990 to 1993. It is justified because of the monetization of government debt and inflow of capital. Government debt measured by the RBI credit to government averaged 294.52 billion rupees during 1981-93, and 568.41 billion rupees during 1992-1993. RB is significant, though its elasticity is small. Demand for currency has unit elasticity with respect to GDP. The DW statistics is somewhat less than the critical value. 164 India's Economic Prospects Despite the problems raised by Chick and referred to in Sec. 7.1, we have estimated the demand function in real terms with nominal interest rate. Currency deflated by IP_GDP is (RC). RGDP, nominal RB, the dummy variable Z9093, and the lagged variable are used as arguments in the fuction. The estimated equation follows. (6.2) The long-run income elasticity is about one. This is in conformity with the Cambridge formulation. In the previous equation where nominal quantities are used without the lag structure we obtain a unitary income elasticity. No serial correlation is present in the above equation as judged by the DW or H statistic.
- G. Fontana, M. Setterfield, G. Fontana, M. Setterfield(Authors)
- 2016(Publication Date)
- Palgrave Macmillan(Publisher)
Arestis, P. and Sawyer, M. (2006), ‘Aggregate demand, conflict and capacity in the inflationary process’, Cambridge Journal of Economics, 29(6), 959–74. Arestis, P. and Sawyer, M. (2007), ‘The nature and role of monetary policy when money is endogenous’, Cambridge Journal of Economics, 30(6), 847–60. Dernburg, T.F. and McDougall, D.M. (1963), Macro-economics, London: McGraw-Hill. Friedman, M. (1969), ‘The quantity theory of money: a restatement’, in M. Friedman, The Optimum Quantity of Money and other essays, London: Macmillan, 51–68. Godley, W. (1999), ‘Money and credit in a Keynesian model of income determination’, Cambridge Journal of Economics, 23, 393–411. Godley, W. and Lavoie, M. (2007), Monetary Economics: An Integrated Approach to Credit, Money, Income, Production, and Wealth, Basingstoke: Palgrave Macmillan. Lavoie, M. (1992), Foundations of Post-Keynesian Economic Analysis, Aldershot: Edward Elgar. Lavoie, M. (2003), ‘A primer on endogenous credit money’, in Rochon, L.P. and Rossi, S. (eds), Modern Theories of Money, Cheltenham: Edward Elgar. Romer, D. (2000), ‘Keynesian macroeconomics without the LM curve’, Journal of Economic Perspectives, 14(2), 149–69. Taylor, J.B. (1993), ‘Discretion versus policy rules in practice’, Carnegie-Rochester Conference Series on Public Policy, North Holland, 39, 159–214. 8 A Simple (and Teachable) Macroeconomic Model with Endogenous Money Giuseppe Fontana and Mark Setterfield 1 Introduction According to Romer (2000), the IS–LM framework has outlived its useful- ness as the basic model for teaching undergraduate students about short-run macroeconomic fluctuations. This is because central banks no longer use monetary aggregates as the instrument of monetary policy (as per the assump- tions of the IS–LM model), but instead conduct policy by manipulating interest rates (see also Blinder 1997; Taylor 1997; Walsh 2002).
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