Explain the Post-Keynesian Transaction Demand for Money and Discuss the Effect That the Distribution of Income Will Have on the Determination of the Demand for Real Balances
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At the time of writing Keynes’ approach to the demand for money was radical. However, The General Theory received much criticism and lead other economists to try and justify Keynes’ findings, particularly in respect to the inverse relationship between the interest rate and the demand for money. Of these, the most widely quoted model is the Baumol/Tobin inventory-theoretic-model developed separately by William Baumol (1952) and James Tobin (1956) resulting in similar conclusions. They are often referred to as Neo-Keynesian models as they agree with a central argument in Keynes’ general theory that the monetary and real sectors of the economy are related through interest rates. (Howells & Bain, 2009, p433)
To be able to draw precise conclusions about the variables that determine this segment of the demand for money a number of assumptions are made. A) The model assumes that an individual agent, be it a firm or household, receives a known lump-sum payment of T once at the start of each period, say one year. All income received is spent at a constant rate over the period. B) The individual can invest the payment in interest yielding financial asset such as bonds that pay a known interest rate r if held for a full month or proportionately less than this if held for a shorter amount of time, or they can hold money in cash form paying no interest. C) In order to obtain cash in equal amounts of K, the individual must sell bonds. Therefore, at the start of the period, the individual will exchange most of T for bonds and then periodically exchange bonds for cash as purchases are made. The more transactions from bonds to cash increases the average bond holding and consequently the interest earned increases. However these exchanges are subject to a brokerage fee of b per transaction, this is assumed to be fixed. Therefore, the number of transactions are determined by a trade off between the costs of transactions and the earning on bonds in term of
At the time of writing Keynes’ approach to the demand for money was radical. However, The General Theory received much criticism and lead other economists to try and justify Keynes’ findings, particularly in respect to the inverse relationship between the interest rate and the demand for money. Of these, the most widely quoted model is the Baumol/Tobin inventory-theoretic-model developed separately by William Baumol (1952) and James Tobin (1956) resulting in similar conclusions. They are often referred to as Neo-Keynesian models as they agree with a central argument in Keynes’ general theory that the monetary and real sectors of the economy are related through interest rates. (Howells & Bain, 2009, p433)
To be able to draw precise conclusions about the variables that determine this segment of the demand for money a number of assumptions are made. A) The model assumes that an individual agent, be it a firm or household, receives a known lump-sum payment of T once at the start of each period, say one year. All income received is spent at a constant rate over the period. B) The individual can invest the payment in interest yielding financial asset such as bonds that pay a known interest rate r if held for a full month or proportionately less than this if held for a shorter amount of time, or they can hold money in cash form paying no interest. C) In order to obtain cash in equal amounts of K, the individual must sell bonds. Therefore, at the start of the period, the individual will exchange most of T for bonds and then periodically exchange bonds for cash as purchases are made. The more transactions from bonds to cash increases the average bond holding and consequently the interest earned increases. However these exchanges are subject to a brokerage fee of b per transaction, this is assumed to be fixed. Therefore, the number of transactions are determined by a trade off between the costs of transactions and the earning on bonds in term of
Bibliography: Baumol, W. J. (Nov., 1952). The Transactions Demand for Cash: An Inventory Theoretic Approach. The Quarterly Journal of Economics, Vol. 66, No. 4, 545-556. Branson, W. H. (1989). Macroeconomic Theory and Policy (3rd ed.). New York: Harper & Row, 335-346. Cuthbertson, K. (1985). The Supply and Demand For Money. New York: Basil Blackwell, 21-28. fisher, D. (1989). Money Demand and Monetary Policy. London: Harvester Wheatsheaf. Howells, P and Bain, K. (2009). Monetary Economics, Policy and its Theoretical Basis. New York: Palgrave, 73-76. Keynes, J. M. (1923). The General Theory of Unemployment, Interest, and Money. London & New York: Macmillan. Laidler, D. E. (1985). The Demand for Money: Theories, Evidence, and Problems (3rd ed.). New York: Harper & Row, 59-63. Tobin, J. (1956). The Interest Elasticity and Transactions Demand for Cash. Review of Economics and Statistics, 38 (August), 241-247. [ 3 ]. The assumptions outlined give the simplest version of the model developed by Baumol without the mathematical complexities involved in the more elaborate work of Tobin (Laidler, 1985) [ 4 ]