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Is velocity constant? 1. Classicals thought V constant because didn’t have good data 2. After Great Depression, economists realized velocity far from constant

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**Liquidity Preference Analysis**

Derivation of Demand Curve 1. Keynes assumed money has i = 0 2. As i , relative RE on money (opportunity cost of money ) Md Demand curve for money has usual downward slope QDM = f(i; Y, P) Income Effect: Y => QDM at each i (DM ) Y =>W =>DM as medium of exchange and store of value Price Level Effect: P =>QDM at each i (DM ) People care about purchasing power of money, real money balances = X = M/P

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**Chapter 19: The Demand for Money**

Theories of MD Classical Theory (1900 Fisher) Keynesian Theory Quantity Theory (Friedman) Big Questions: How is PY determined Is MD = f (i) Does DM => DP => DY AS P AD PxY Y i MD = f (Y, P) MD = f (i;Y, P) Q of M

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**(rate of money turnover) W, i, & P flexible => Y = YFE**

Velocity of Money = V (rate of money turnover) (link between M & PY) M x V = P x Y DM/M + DV/V = DP/P + DY/Y DP/P = DM/M + DV/V - DY/Y If DV/V = 0, Then DP/P = DM/M - DY/Y If DM/M > DY/Y Then DP/P > 0 If DM/M = DY/Y Then DP/P = 0 Milton Friedman: “Inflation is everywhere and always a monetary phenomenon” Equation of Exchange (identity) Inflation Irving Fisher’s assumption Quantity Theory of Money (PY determined solely by Q of M) Classical School assumes W, i, & P flexible => Y = YFE So M => P Or DM/M => DP/P

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**Implication: MD not a fn of i MD is a fn. of tech./fin. innovation**

Quantity Theory of Money Demand M = (1/V) x P Y (in eqlm M = MD) MD = (1/V) x P Y MD = k x P Y Implication: MD not a fn of i MD is a fn. of PY (medium of exchange) MD is a fn. of tech./fin. innovation (1/10 and falling)

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**Keynes’s Liquidity Preference Theory**

3 Motives/Components of MD Transactions motive —related to Y Checking accounts Precautionary motive —related to Y Savings accounts 3. Speculative motive A. related to W and Y B. negatively related to i Money market accounts

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07 06 01 95 00 98 97 96 99 05 04 02 03 92 94 93

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**Chapter 19 Homework Due Friday, April 18**

Econ 330 Chapter 19 Homework Due Friday, April 18 Chapter 19 Questions & Applied Problems 2, 5, 7, 11, 14, 21, 24, 25

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TM 14-1 Copyright © 1998 Addison Wesley Longman, Inc. Motives for Holding Money Transaction.

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