Review the emperical evidence Regarding the elasticity of demand for money

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Introduction

Appropriate demand function for money balance is an issue that has brought great controversy among economists across the globe . However the whole controversy has over and over rotated around three major empirical problems . First , is the question of whether one should include time or savings deposits in money ? Second is on what is the right constraint balances should it be current income or wealth . Lastly , whether money balances is affected in anyway by interest rates and if at all they do

is it the short or long rates that affect money balance (P . Laumas , G Laumas Jul 1969

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The main difference between monetarist and Keynesians are mainly surrounding empirical magnitudes however this has not yet been proved giving room for examination of evidence to give a deeper insight Studies conducted in the US revealed a relationship between money and economic activities . The founders used data available from 1867 to 1960 researched on length and time lag involved in money matters . The results found were that supply for money preceded highs in the level of economic activity . As a result of lags constant money growth rate was the optimal monetary policy (Friedman and Schwartz 1963

However Empirical evidence compared the rate of money supply with levels of economic activity . This may have faulty results since at times rate of change may peak before the level actually does . This automatically affects money supply and the level of economic activity This argument automatically criticises the empirical evidence since Money supply can be reacting to other factors like increase in income

The variables may also be influenced by other variables like a budget deficit . When an economy is faced with a budget deficit , it forced to either issue government securities or print more money . This realises an increase in the level of money supply and in return affecting income Again such theories tend to weaken the empirical evidence

People 's expenditure can also affect elasticity of demand for money . If the expenditures of individuals fall , they tend to demand for less money and this pushes supply low . The income version of the quantity theory of money can be expressed as

MV PY

Where M is the stock of nominal cash in circulation into economy and Y is the real income .

is price and V velocity . In the equation V PY /M money in the hands of the public is defined as the number of times /units time that money is applied as a means of effecting transactions . Meaning (V PY /M ) the quantity theory is a more tautology . This is because in to make the equation fit the theory of price level , V and Y must be keenly considered and a derivation of M made (Alan D 1996

Demand for money is also closely affected by interest rates . Tobin discovered that demand for money and interest rates have a clear relationship after he compared idle balances (the difference between transactions balances and any other form...