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

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

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

(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

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)

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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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