• BEO2000 Financial Institutions & Monetary Theory
• Lecture 2: Theories of the Demand for Money
• Primary Sources:
• Serletis, 2007, Ch. 7: The Classics, Keynes, and Friedman
• Sen, G.C., 2013, Keynes’ Theory of Demand for Money
• Learning Outcomes
• With respect to learning outcomes, you should be able to:
• a. Identify the meaning and function of money;
• b. Review Fisher’s Quantity Theory of Money;
• c. Explore Keynes’s Liquidity Preference Theory;
• d. Review developments of Keynes’s theory and response (e.g. B-T Transaction model and
Tobin’s Portfolio model);
• e. Review Friedman’s Modern Quantity Theory of Money;
• f. Review empirical evidence for support of theories.
• Meaning of Money
• There is no commonly accepted general definition of money. However, working definitions
abound.
• Economists meaning of money:
– (i) Anything that is generally accepted as a means of payment for goods and
services.
• Thus, it must serve as a medium of exchange.
– (ii) Not the same as wealth and income.
• Primary Functions of Money
• There are three main primary functions of money.
1. Medium of Exchange
• An item that buyers give to sellers when they purchase goods and services.
• This exchange (transfer of money) allows transaction to take place.
• Avoids the inconveniences of a pure barter system.
• Primary Functions of Money
2. Unit of Account
• An agreed measure of value.
• Evaluates cost of goods, services, assets, liabilities, income, etc.
, 3. Store of Value
• Money needs to hold its value over time.
• It is not the only store of value in the economy.
• Demand for Money
• Key to understanding the lecture:
• Money demand refers to the desired holding of financial assets in the form of
money.
• (i.e.,) Holdings of money in the form of cash or bank deposits.
• Trade-off:
• Liquidity advantage vs. interest advantage.
• Demand for money results from this trade-off.
• There is an opportunity cost of holding money:
• Money earns little, or no, interest.
• Money loses purchasing power to inflation.
• The Quantity Theory of Money
• Fisher (1911) equates money demand to undertaking transactions (i.e., transactions
motive).
• Thus, he examines the nominal value of transactions in the economy via the
following:
Equation of Exchange: M * V = P * Y
Where:
M = quantity of money (the money supply)
V = velocity of money (average number of times per year that a dollar is spent)
P = price level
Y = aggregate output (aggregate income)
• The Quantity Theory of Money
• Velocity of money
• The average number of times a dollar is spent in buying the total amount of
final goods and services.
• It equates to the turnover rate for money in the economy.
• Rearranging the equation of exchange we arrive at:
P*Y Total spending
• Lecture 2: Theories of the Demand for Money
• Primary Sources:
• Serletis, 2007, Ch. 7: The Classics, Keynes, and Friedman
• Sen, G.C., 2013, Keynes’ Theory of Demand for Money
• Learning Outcomes
• With respect to learning outcomes, you should be able to:
• a. Identify the meaning and function of money;
• b. Review Fisher’s Quantity Theory of Money;
• c. Explore Keynes’s Liquidity Preference Theory;
• d. Review developments of Keynes’s theory and response (e.g. B-T Transaction model and
Tobin’s Portfolio model);
• e. Review Friedman’s Modern Quantity Theory of Money;
• f. Review empirical evidence for support of theories.
• Meaning of Money
• There is no commonly accepted general definition of money. However, working definitions
abound.
• Economists meaning of money:
– (i) Anything that is generally accepted as a means of payment for goods and
services.
• Thus, it must serve as a medium of exchange.
– (ii) Not the same as wealth and income.
• Primary Functions of Money
• There are three main primary functions of money.
1. Medium of Exchange
• An item that buyers give to sellers when they purchase goods and services.
• This exchange (transfer of money) allows transaction to take place.
• Avoids the inconveniences of a pure barter system.
• Primary Functions of Money
2. Unit of Account
• An agreed measure of value.
• Evaluates cost of goods, services, assets, liabilities, income, etc.
, 3. Store of Value
• Money needs to hold its value over time.
• It is not the only store of value in the economy.
• Demand for Money
• Key to understanding the lecture:
• Money demand refers to the desired holding of financial assets in the form of
money.
• (i.e.,) Holdings of money in the form of cash or bank deposits.
• Trade-off:
• Liquidity advantage vs. interest advantage.
• Demand for money results from this trade-off.
• There is an opportunity cost of holding money:
• Money earns little, or no, interest.
• Money loses purchasing power to inflation.
• The Quantity Theory of Money
• Fisher (1911) equates money demand to undertaking transactions (i.e., transactions
motive).
• Thus, he examines the nominal value of transactions in the economy via the
following:
Equation of Exchange: M * V = P * Y
Where:
M = quantity of money (the money supply)
V = velocity of money (average number of times per year that a dollar is spent)
P = price level
Y = aggregate output (aggregate income)
• The Quantity Theory of Money
• Velocity of money
• The average number of times a dollar is spent in buying the total amount of
final goods and services.
• It equates to the turnover rate for money in the economy.
• Rearranging the equation of exchange we arrive at:
P*Y Total spending
