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

2. 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

3. 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

4. (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

5. 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)

6. 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

14. 07 06 01 95 00 98 97 96 99 05 04 02 03 92 94 93

16. 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