Question

“Contrary to the view of Keynesians, Milton Friedman argued that the demand for money was stable and also maintained that the interest elasticity of money demand was certainly not infinite.” Elaborate

Answer 1

The theory of Milton Friedman is antithetical to the view of Keynesians. In contrast to the near-liquidity-trap characterization, Friedman believed that the interest elasticity of money demand would not be infinite and was in fact. He argued on the stability for the demand of money; and considered quantity of money to be a significant and dominant factor on the level of activities in an economy. Keynes theory of money demand laid emphasis on the importance on money's role and treated it to be an asset in addition to its role in transactions. Milton Friedman accepted the role of money as an asset but viewed the money demand function to be stable because in contrary to the Keynesians view's the Friedman does not segment the money demand into the components reflecting the speculative demand, transactional balances and precautionary demand. Also Friedman included the separate yields for equities, bonds and durable goods. Thus Friedman money demand function can be written as:

Md = L (P, Y, rB, rE, rD) where;

Md is money demand; P is price level; Y is real income; rB is nominal rate of interest in bonds; rE is nominal return on equities; rD is nominal return on durable goods)

It can be re-written as: Md = k (rB, rE, rD) PY; thus k takes into consideration the role of money as an asset as stated by Keynesian. An increase in the rate of return in any of these assets would cause a decline in k, thus depicting the desirability of an alternative asset. Friedman considered the interest elasticity of money demand to be low