Real Money Supply Flowing Around
Real Money Supply Flowing Across
Real Money Supply Flowing Together

Read this article to learn about the friedman’s restatement of the quantity theory of money:

The money supply represents the whole of deposits in financial institutions, or the money outstanding and not accounted for by any other measure. This money is often very fluid, flowing in and out of the system, and is a key measure of economic health. If the money supply is too much, inflation could result. Real flows refer to the flow of the actual goods or services, while money flows refer to the payments for the services (wages, for example) or consumption payments.

Following the publication of Keynes’s the General Theory of Employment, Interest and Money in 1936 economists discarded the traditional quantity theory of money. But at the University of Chicago “the quantity theory continued to be a central and vigorous part of the oral tradition throughout the 1930s and 1940s.”

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At Chicago, Milton Friedman, Henry Simons, Lloyd Mints, Frank Knight and Jacob Viner taught and developed ‘a more subtle and relevant version’ of the quantity theory of money in its theoretical form “in which the quantity theory was connected and integrated with general price theory.” The foremost exponent of the Chicago version of the quantity theory of money who led to the so-called “Monetarist Revolution” is Professor Friedman. He, in his essay “The Quantity Theory of Money—A Restatement” published in 1956′, set down a particular model of quantity theory of money. This is discussed below.

Friedman’s Theory:

Real Money Supply Flowing Around

In his reformulation of the quantity theory, Friedman asserts that “the quantity theory is in the first instance a theory of the demand for money. It is not a theory of output, or of money income, or of the price level.” The demand for money on the part of ultimate wealth holders is formally identical with that of the demand for a consumption service. He regards the amount of real cash balances (M/P) as a commodity which is demanded because it yields services to the person who holds it. Thus money is an asset or capital good. Hence the demand for money forms part of capital or wealth theory.

For ultimate wealth holders, the demand for money, in real terms, may be expected to be a function primarily of the following variables:

1. Total Wealth:

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The total wealth is the analogue of the budget constraint. It is the total that must be divided among various forms of assets. In practice, estimates of total wealth are seldom available. Instead, income may serve as an index of wealth. Thus, according to Friedman, income is a surrogate of wealth.

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2. The Division of Wealth between Human and Non-Human Forms:

The major source of wealth is the productive capacity of human beings which is human wealth. But the conversion of human wealth into non-human wealth or the reverse is subject to institutional constraints. This can be done by using current earnings to purchase non-human wealth or by using non-human wealth to finance the acquisition of skills. Thus the fraction of total wealth in the form of non-human wealth is an additional important variable. Friedman calls the ratio of non-human to human wealth or the ratio of wealth to income as w.

3. The Expected Rates of Return on Money and Other Assets:

Real Money Supply Flowing Across

These rates of return are the counterparts of the prices of a commodity and its substitutes and complements in the theory of consumer demand. The nominal rate of return may be zero as it generally is on currency, or negative as it sometimes is on demand deposits, subject to net service charges, or positive as it is on demand deposits on which interest is paid, and generally on time deposits. The nominal rate of return on other assets consists of two parts: first, any currently paid yield or cost, such as interest on bonds, dividends on equities, and costs of storage on physical assets, and second, changes in the prices of these assets which become especially important under conditions of inflation or deflation.

4. Other Variables:

Variables other than income may affect the utility attached to the services of money which determine liquidity proper. Besides liquidity, variables are the tastes and preferences of wealth holders. Another variable is trading in existing capital goods by ultimate wealth holders. These variables also determine the demand function for money along-with other forms of wealth. Such variables are noted as u by Friedman.

Broadly, total wealth includes all sources of income or consumable services. It is capitalised income. By income, Friedman means “permanent income” which is the average expected yield on wealth during its life time.

Wealth can be held in five different forms: money, bonds, equities, physical goods, and human capital. Each form of wealth has a unique characteristic of its own and a different yield.

1. Money is taken in the broadest sense to include currency, demand deposits and time deposits which yield interest on deposits. Thus money is luxury good. It also yields real return in the form of convenience, security, etc. to the holder which is measured in terms of the general price level (P).

2. Bonds are defined as claim to a time stream of payments that are fixed in nominal units.

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3. Equities are defined as a claim to a time stream of payments that are fixed in real units.

Earn real money with online games. 4. Physical goods or non-human goods are inventories of producer and consumer durable.

5. Human capital is the productive capacity of human beings. Thus each form of wealth has a unique characteristic of its own and a different yield either explicitly in the form of interest, dividends, labour income, etc., or implicitly in the form of services of money measured in terms of P, and inventories. The present discounted value of these expected income flows from these five forms of wealth constitutes the current value of wealth which can be expressed as:

W = y/r

Where W is the current value of total wealth, Y is the total flow of expected income from the five forms of wealth, and r is the interest rate. This equation shows that wealth is capitalised income. Friedman in his latest empirical study Monetary Trends in the United States and the United Kingdom (1982) gives the following demand function for money for an individual wealth holder with slightly different notations from his original study of 1956 as:

M/P = f (y, w; R_m, R_b, R_e, g_p, u)

Where M is the total stock of money demanded; P is the price level; у is the real income; w is the fraction of wealth in non-human form: R_m is the expected nominal rate of return on money; R_b is the expected rate of return on bonds, including expected changes in their prices; R_e is the expected nominal rate of return on equities, including expected changes in their prices; g_p=(1/P) (dP/dt) is the expected rate of change of prices of