• The theory can justify the conclusion from the Keynesian liquidity preference function that the demand for real money balances is positively related to income and negatively related to the nominal interest rate. Positively negatively.
  • This excess demand for goods, in turn, will cause over time some positive inflation. As the price level goes up, the real money supply M/P will fall (since M is exogenously given and P is increasing); this fall in real money balances leads to a shift to the left of the LM curve that starts to move from LM' to LM'.

The quantity of real money balances supplied is an exogenous value equal to M P s = M &conjugate0; P &conjugate0; where M &conjugate0; is the nominal money supply (as determined by the central bank's monetary policy) and P &conjugate0; is the short-term fixed price level.

Corrections

All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:mcb:jmoncb:v:11:y:1979:i:3:p:326-39. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879 .

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

Real money balances m park

We have no bibliographic references for this item. You can help adding them by using this form .

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the 'citations' tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley-Blackwell Digital Licensing or Christopher F. Baum (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879 .

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

Dissatisfied with Pigou’s equation, Keynes formulated his own equation called “The Real Balance Quantity Equation” which is as under:

P = n/k

Where, n is the quantity of money in circulation,

ADVERTISEMENTS:

p is the price of a consumption unit,

k refers to the real balance. It is measured as the amount of consumption units (viewed as a set of specified quantities of the people’s standard items of consumption) the community prefers to hold in the form of cash.

It is easy to see that if k is constant, a change in causes a proportional change in p.

To consider the bank deposits component of money supply, Keynes extended the equation as follows:

P = n/k + rk’

Where, r denotes cash reserve ratio, i.e., the proportion of cash reserves maintained by banks against their deposits.

k stands for the real balance held in the form of bank money.

Thus, if k, k’ and r remain unchanged, n and p will directly vary in the same proportion.

Real money balance

Real Money Balance

ADVERTISEMENTS:

Keynes, however, does not regard that k and k’ are independent of n – the stock of money. Again, k and k’ may not be affected by small changes in the stock of money.

But they are bound to be affected by large changes in the stock of money. When k, k’ and r are influenced by n, there is no fully proportionate variation of p caused by changes in n.

In reality, p will change as per the changes in the ratio n/k’

Thus, Keynes’ approach is more rational than that of Pigou.

Keynes’ real balance equation, however, is not free from defects. In fact, Keynes himself had recognised certain defects in it, which he pointed out later, in his Treatise on Money, as discussed below:

1. In Keynes’ equation, P refers only to the price level of consumption standard value of money, in a narrow sense. In other words, P does not measure the purchasing power of money in a general sense.

2. The real balance equation disregards industrial and financial transactions; hence its application is limited.

3. When P measures only the price level of consumption units, the equation seems to suggest that people hold money only to secure consumption goods. But in reality, people hold money for a “vast multiplicity of business and personal purposes” and with a multiplicity of motives, such as transactionary, precautionary and speculative.

ADVERTISEMENTS:

4. There is no justification for deducing a proportional relationship between n and p in the short period from the equation, when k, k’ and r might, and do, change as a result of changes in.

Recognising that a change in n will affect k, k’ and r, Keynes himself admits, as we have noted above, that in a short period, there is no proportionate relationship between n, the quantity of money, and P, the price level, though in the long run, he feels such a relationship would be normal.

New Balance M

But, on the other hand, in his Tract on Monetary Reform, Keynes assumed constant levels of output and employment and followed the conclusion that when n is changed, volume of output remaining constant, the net effect would be a proportionate change in the price level. But, in fact, in the short period, the levels of output and employment are subject to changes.

However, the shortcomings of the Tract equation have been overcome by Keynes in his General Theory.

He had integrated the theory of money with the theory of output, and ascertained that the quantity theory of money subsists only in a state of full employment. In a state of under-employment, changes in prices are caused by changes in the level of income rather than in the money supply.

Keynes thereby abandoned the cash balances approach, and adopted the income-expenditure approach to the value of money.

Related posts: