ABSTRACT
The pure theory of the demand for money assumes a given nominal supply of money which is varied at the discretion of the monetary authorities and government. Demand theory sets out to analyse the effects on general equilibrium of a change in the nominal quantity of money or of a change in demand for money arising from an exogenous change in tastes. (Traditionally the demand for money in the UK has been regarded as stable, but it has not always proved so). This branch of monetary economics also assumes that the authorities can control the nominal quantity of money. In contrast to this view there has always been a school that sees the supply of money responding to demand; it therefore concludes that there is no point in attempting to control the economy by monetary policy. Hence a theory of money, if it is to be consistent, requires that supply be determined independently of the demand for money, and if the theory is to be of use, it must allow that the central bank can control the quantity of money in the hands of the public. It must determine the nominal supply and not real balances: the demand for money is a demand for real balances and the public can determine any quantity of real balances it wishes via the price level. An element of ‘money illusion’ is usually ascribed to the authorities because their concern is with the price level and so the nominal rather than real quantity of money as such.
