Page 139 - DECO402_Macro Economics

Macroeconomic Theory

Notes keep in the cash or bank deposits form, is related with their permanent income constantly. If central
bank on purchasing the securities of money will increase the money supply, then those people who
will sell their securities, will see that the holders of their money are increased in the proportion of
their income. So, they will spend their excess holdings of money partially on assets and partially on
consuming goods and services. Their money remaining will reduce from this expense and at the
same time nominal income will be increased. On the other side, when central bank will reduce the
money supply from selling the securities, the money holdings of securities buyers will be lesser in
the proportion of their permanent income. So, they on partially selling the securities and spending
their consumption partially on goods and services will increase their money holdings. The nominal
income will started to reduce from it. Therefore from both the ways the demand of money is constant.
According to Friedman, if there is change in money stock, then there is the change in equal proportion
in price level or in income or in both the income and price level. On giving the money demand, then
it is possible to forecast the effects of changes in money supply on total expenditure or income. Is
economy is on lower level from full employment then increment in money-supply on increasing
total expenditure will make an increment in production and employment. But it is only possible in
short time period. The Quantity Theory of Money of Friedman is shown by the figure 15.1, where
income is measured on vertical axis and the supply and demand of money on horizontal axis. M is
b
the demand curve of money which changes with income. MS is the money supply curve which is fully
inflexible with the changes of income. Both the curves coincides each-other on E and determine the
balanced income OY. If money supply increases then MS curve on shifting towards right becomes M
1
S . Consequently, money-supply becomes greater than demand of money which increases the total
1
income until there is not established a new balance in M and M S on point E . Therefore, income
b
1
1
1
on being increased became OY .
1
Conclusion: In conclusion, Friedman presents Quantity Theory in the form of Demand of Money
Theory and considers demand of money on assets prices or respective return and wealth or income.
He shows that how demand of money becomes the theory of prices and production. The difference
in nominal quantity of demanded money and nominal quantity of supplied money will be shown
in the tried expense mainly. When the demand of money is changed in reaction of changes in it’s
determiners, then in the resulting of it the sufficient change in prices or nominal incomes occurs
because of changes in supply money always approximately.
Criticism

The Restatement of Quantity Theory of Money of Friedman has started a heavy debate and empirical
investigation if done from Keynesians and monetarists. The discussion of accusations against
Friedman’s theory is as follows:
1. Very Broad Definition of Money: One accusation
on Friedman is that he has used such broad
definition of money in which not only currency
and demand deposits (M ) but the term deposits
1
of commercial banks (M ) are also included. The
2
clear conclusion from this definition is found
that the interest flexibility of demand of money
is negligible. If the interest rate on term deposit
increases then their (of M ) demand increases.
2
But the demand of currency and term deposits
(M ) falls. So the total effect which will occur on
1
demand of money will approximately negligible.
But the weakness of Friedman’s analysis is that
it doesn’t differentiate in long term and short Figure 15.1

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