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Money and credit - Ivanov V.М.

9.4. The modern theory of demand for money

Modern monetary theory is a Keynesian-neoclassical synthesis, which includes elements common to both theories and the achievement of modern scientific thought.

The modern theory of demand for money has a number of distinctive features.

1. The modern theory of demand for money considers a wider range of assets than interest-free storage of money and long-term bonds. Currently, investors can have portfolios with both interest-bearing forms of money (for example, account-accounts) and non-interest-bearing forms (cash and demand deposits). In addition, they can have savings, term deposits, short-term government securities, corporate bonds and shares, real estate, and durable goods. At the same time, anything that influences the preference for owning any of the above assets with respect to money can affect the amount of demand for money.

2. Modern theory rejects the explanation of the demand for money by a precautionary motive, by transactional and speculative motives of storing a part of assets in the form of money. The interest rate affects the demand for money only because the rate of interest is an alternative cost of storing money.

3. Modern theory considers wealth as one of the determinants of demand for money. With an increase in the wealth of the individual, he will probably want to increase each of the types of wealth that belong to him, including money.

4. Modern theory also considers other factors that affect the desire of economic agents to prefer a liquid portfolio. For example, such a factor can be changes in expectations. With a pessimistic forecast for the future conjuncture, the demand for money tends to grow, and with an optimistic economic agent, it will prefer other types of assets.

5. The modern theory of demand for money takes into account the existence of inflation. This theory clearly delineates such concepts as real and nominal income, real and nominal interest rates, real and nominal size of the money supply.

The growth of nominal national income (the national product) may be caused by an increase in the price level with a fixed real national income (product) or some symbiosis of these two phenomena. In any case, changes in the nominal national income will affect the amount of demand for money. Therefore, when discussing the mutual relationship between output and demand for money, it is necessary to take into account the price level. This can be done, for example, by dividing the nominal national product and the amount of money in circulation by the price level index. As a result, a change in the price level, other things being equal, does not affect the expected demand for real cash balances.

The change in the price level must also be taken into account when analyzing the relationship between the rate of interest on assets that business agents hold in their portfolios as an alternative to money and the demand for money. In the ideal case, that is, in the absence of inflation, the rate of interest is the return on assets that can be stored as an alternative to money. The rate of interest measures the alternative cost of keeping non-interest-bearing cash and is equivalent to benefiting from the advantages of portfolio liquidity: the higher the rate of interest on alternative assets, the higher their alternative cost and the lower the demand for money.

In the real world, there is inflation that undermines the usefulness of money as a means of saving, since the real volume of goods and services that can be purchased for a certain amount of non-interest-bearing cash falls at a rate equal to the rate of growth in the price level. Therefore, the real rate of interest on alternative assets is not the entire alternative cost of keeping non-interest-bearing cash. An additional alternative cost is the rate of inflation. And the sum of these values ​​is the expected nominal rate of interest.

As a result, the function of demand for money can be represented as a functional dependence of the demand for nominal cash balances on nominal national income and the rate of interest.

It should be noted that the speed of circulation of money as a variable that determines the magnitude of the demand for money does not disappear. From equation

It follows that y is the ratio of nominal national income to the value of the alleged demand for money.

In the modern interpretation of the concept of demand for money, the velocity of circulation of money is a variable that depends on the nominal rate of interest. As we move along the demand curve for money (the latter has a negative slope based on the general law of demand), y falls in proportion to the decrease in the nominal rate of interest and increases with the growth of the nominal rate of interest.