The Demand for Money

This chapter presents the demand for money and its components in a modern economy. Notably, the demand for money is driven by transaction, precautionary, and speculative motives. The demand for the money model considered two assets: non-income-earning money and income-earning nonmoney assets called bonds. The demand for money varies inversely with interest rates. Thus, higher interest rates cause a greater demand for bonds and lower demand for money. The demand for money changes as a result of a change in real GDP, the price level, transfer costs, expectations, or preferences. All other things unchanged, a shift in money demand or supply will lead to a change in the equilibrium interest rate and therefore to changes in the level of real GDP and the price level. This chapter also describes the relationship between the quantity theory of money and the demand for money. The quantity theory was originally stated as a proportionality relation that holds in the long-run between the quantity of money and the price level.