Friedman’s restatement of the quantity theory of money and supply of money
Milton Friedman with other economists at Chicago developed a subtler and more relevant version of the quantity theory of money in its theoretical form in which the quantity was connected and integrated with the general price theory
Friedman asserts that the quantity theory is a theory f demand for money
It is not a theory of output or of money income or of the price level
In regards to the amount of real cash balance (m/p)
Where m-stock of money in circulation as a commodity which is demanded because yields services to the persons 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 function primarily on the following variables
- Total wealth
In evaluating total wealth, we use the analogue of budget constraint which is the total that must be divided among various forms of assets.
In practice estimates of total wealth can be used to measure the richness of an individual but because of the unavailability of data, income can be used as an index of wealth thus according to Friedman, income is a surrogate of wealth
- Division of wealth between human and nonhuman forms
Human wealth is the productive capacity of human beings but the conversion of human wealth into non-human wealth or the reverse is subject to institutional constraints
This can be done 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 addition to important variables
Friedman posed the ratio of non-human to human wealth or the ratio of wealth to income as w
- Expected rates of return on money and other assets
These rates of return are the counterparts of the prices of a commodity and its substitutes and complements the theory of consumer demand
The nominal rate of return may be zero as it is generally on currency or negative as sometimes it is on-demand deposits
The nominal rate of returns on other assets consist of two parts first, any currently paid yield or cost such as interest on bond, dividends on equities and cost of storage on physical assets
Secondly, changes in the prices of these assets which become important under conditions of inflation therefore the expected rate of return on assets r can be rate of return on money rm, rate of return on bonds rb and rate of return on equities re
r= rm +rb+te
- The price level
Higher price levels mean that people require a large nominal money balance in order to do the same amount of transactions.
- Expected rates of inflation
If the higher rate of inflation is expected people will reduce the demand for money holdings since inflation reduces the values of real money balances in terms of power to purchase goods and services
- Institutional factors
They include mode of wage payments, recession, instability of capital markets which erodes the confidence of people in making investments etc.
Friedman’s restatement quantity of money can be formulated ad
m/p =f (u, w, rm, rb, re, p, dp/p, u)
where;
u is institutional factors
rb is return on bonds
rm is return on money
p is price level
dp/p is first derivative of price
w is ratio of non-human to human wealth or the ratio of wealth to income
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