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Modern Monetarist Theory

The post-Keynesian approach to the demand for money is that the quantity of money demanded in ant economy is not only a function of income and interest rates, as Keybes has made out, but a number of other variables such as wealth and permanent income. Interest rates on various type of financial assets and not merely bonds would lead to interest rate changes. Expected price, interest rate change, tasted, prefaces of people, etc., would also influence the demand for money.

Determinants of Demands for Money

The demand for money depends on: (1) the general price level, (2) yield on bonds, (3) the ratio fo non-human wealth to human wealth, (4) the total wealth that individual owns, and (5) tastes and preferences.

The demand function of money, the, is as follows:

MD = f (P,W,r - 1/R. dr/dt. 1/p.dp/dt. h)

where MD is the demand for money balance, ‘r’ is the rate of interest, ‘W’ is wealth, ‘h’ is ratio of non-human wealth to human wealth, ‘p’ is the price level, and dr/dt and dp/dt are all time derivatives denoting expected rates of change. 1/r. dr/dt the percentage change of interest rate is used to measure the expected percentage change of capital gain or loss upon holding other assets. This should be subtracted from interest rates to arrive at the rate of returns.

This way of thinking is most prominent in the writings of the Chicago School whose leader is Prof. Milton Friedman. Motion Friedman views the demand for money as part and parcel of the overall problem of determining the demand for all assets-physical and financial. This approach to the demand for money is known as the “Modern Quantity Theory of Money”.

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