Milton Friedman's theory and modern monetarism - Monetary...

Milton Friedman's Theory and Modern Monetarism

Keynesian concept of the demand for money, which includes three key motives - the transaction motive, the precautionary motive and the speculative motive, is criticized, since many of its prerequisites cause a well-grounded doubt. For example, the choice between only two assets - money and bonds, the assumption of the presence of a normal interest rate and its minimum level, a subjective version of the formation of expectations seem to unnecessarily simplify the money process.

With the advent of the theory of the American economist Milton Friedman in 1956, modern monetarists approach the analysis of the demand for money in a different way.

Money is a durable goods that brings a lot of services to its owner. It does not matter for what reasons people want to have money. It is important that people want to have money. This is an empirical fact, not subject to doubt. Therefore, the purpose of economic analysis of money should not be to find motives, but to determine the amount of money that people want to have under different economic conditions.

Money, according to M. Friedman, - "this is a temporary haven of purchasing power". Like any other asset, money is subject to the law of diminishing marginal utility: the more money an individual has, the less their marginal utility becomes. As the marginal utility of money decreases, the individual begins to replace money with other assets, first closest to money (financial assets), then more and more remote, including land, real estate and human capital.

The demand function for money, therefore, depends on a number of variables characterizing the return on various types of assets:

where - the permanent income of the individual; W - the physical wealth of the individual; N - human capital; - expected return on cash deposits; - expected yield of bonds; - expected return on other securities; Р - current (average) price level in the economy; π - the level of inflation in the economy; U - Other factors.

The impact of these factors on money demand is seen as follows.

1. The permanent income and physical wealth of the individual (in the form of land, movable and immovable property) have a positive effect on the amount of money that a person wants to have:

Money is a normal commodity, not an inferior commodity and not an essential item. Elasticity of demand for money on income indicators is higher than one. Money is a luxury commodity, this elasticity can differ significantly from one. People keep money by demanding for their special services - which is similar to the reason that individuals acquire other luxury goods.

The same impact is typical for human capital:

2. The interest rate, representing an alternative price of money, has a negative impact on money demand. However, here the difference in yield between various instruments with interest income matters:

3. Price indicators reveal a different dynamics of demand for money.

On the one hand, there is a flight from money in the period of inflation:

On the other hand, the higher the current prices, the more money you need to service a larger nominal volume of transactions:

Let's compare the views on the monetary demand function of Keynes and Friedman (Table 4.1), which underlie modern polar money theories - Keynesianism and monetarism.

Table 4.1

Comparison of monetary concepts of Keynes and Friedman

Keynes (Keynes)

Friedman

Approach to the theory of money in terms of portfolio theory

Approach to the theory of money in terms of portfolio theory

M D depends on your current income

M D depends on a constant income

M D largely reacts to short-term fluctuations in income during the business cycle

M D hardly reacts to the current fluctuations in income, does not change during the business cycle

Types of assets in the portfolio of individuals: money and government bonds

Types of assets in the portfolio of the individual: a variety of different assets (real and financial assets of different nature - money, bonds, corporate securities, durable goods, houses, land, etc.)

The rate of return of money is zero

The rate of return of money is different from zero and includes: interest payments on cash deposits;

service provided by financial institutions (for example, checks clearing, loan servicing)

The elasticity of money demand by income is equal to one, money is the main necessity

The elasticity of money demand is above unity, money is not a matter of first necessity, but a luxury item

Price elasticity of demand for money is equal to one

Price elasticity of demand for money is equal to one

The factors that determine M D :

price level (P):

real income level ( Y );

market (nominal) rate of interest

The factors that determine M D :

price level ( P );

real income level ( Y );

real interest rate;

rate of inflation;

profitability of other assets

The degree of elasticity of money demand relative to the interest rate

High

Low

The basic specification of the function M D

M D = k 1 i + k 2 PY

k 1 & lt; 0; significant magnitude modulo; 0 & lt; k 2 & lt; & lt; 1; very small

M D = aPY b

a & gt; 0 b & gt; 1

or

We see that, to some extent, Friedman's theory is an extended version of Keynes's theory of money. Those elements of the monetary concept, which Keynes presented in a very concise, laconic form, get a more complex, multicomponent interpretation in Friedman's theory.

But how does the individual make the best choice between different monetary and non-monetary investments? How does it allocate its potential funds between assets with greater or less liquidity, with more or less profitability and risk? This will be discussed in Tobin's theory of money, based on the concept of portfolio analysis.

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