The Fundamentals of Money and Financial Systems

CHAPTER 4

Money Theories and Estimation

Introduction

Keynes’ liquidity preference approach to money demand shook the foundations of the classical quantity theory. For example, Keynes challenged the classical quantity theory’s explanation of the consequence of the effects of an increase in the supply of money. Keynes’ theory demonstrates that velocity need not be, and in fact is not, constant; and demand for money depends on the interest rate, as well as income. This and other components of Keynes’ theory provides an alternative solution to the Great Depression of 1929. Over time, it seemed that the quantity theory was dead. Fiscal policy became the dominant economic policy of the pre- and post-World War II era, at least until Friedman revived ...