I’m reading Rothbard’s The Mystery of Banking (. Slowly digesting the first few chapters. I’m still finding the concept of ‘demand for money’ a bit slippery and want to make sure I’ve got the right idea.
Here’s Rothbard trying to preempt confusion:
We contend that there is a falling demand curve for money in relation to hypothetical PPMs, just as there is one in relation to hypothetical individual prices. At first, the idea of a demand curve for money seems odd. Isn’t the demand for money unlimited? Won’t people take as much money as they can get? But this con- fuses what people would be willing to accept as a gift (which is indeed unlimited) with their demand in the sense of how much they would be willing to give up for the money. Or: how much money they would be willing to keep in their cash balances rather than spend. In this sense their demand for money is scarcely unlimited. If someone acquires money, he can do two things with it: either spend it on consumer goods or investments, or else hold on to it, and increase his individual money stock, his total cash balances. How much he wishes to hold on to is his demand for money.
Is it correct to say that: the demand curve for money describes how the amount of money that people on aggregate are willing and able to keep in their accounts rather than spend (over a given time period), varies according to the purchasing power of money?
Is it correct to say that: the demand curve for money describes how the amount of money that people on aggregate are willing and able to keep in their accounts rather than spend (over a given time period), varies according to the purchasing power of money?
I think you’re on the right track. As the purchasing power of money increases, then people may keep less of it (unit-wise) in cash, and buy more things. If the purchasing power falls, then people may save more (to maintain a certain safety net), or they may buy other things as a store of value if the purchasing power drops too quickly.
It all depends on what the persons goals are, and how much cash they think they need to meet those ends. Obviously, one of those ends may be to maintain a certain level of liquidity, which cash provides.
I think that’s an overly mathematical way of looking at it. It’s not a physical variable.
What has been most helpful to me in understanding the demand for money is to identify the way in which money is unique vis-a-vis any other good: the monetary good does not (because it cannot) have a single, numerical price. An apple sells for 59 cents. An orange sells for $1.39. But what is the price of money? Well, hard to say… it’s 1/0.59 apples or 1/1.39 oranges. The monetary good has as many prices as there are goods in the economy. As Mises pointed out, any choice of a “basket” of goods by which to try to assess the “real” price of money is perfectly arbitrary. I haven’t read Rothbard but I think he addresses this with the PPM.
In any case, PPM is not a price. Money is like any other good in that there is a supply of money and there is a demand for money but money is the one good that has no single, market price. This is because money is the unit of calculation.
Demand for money, like demand for coffee, shoes, or any other good, is made up of two components: reservation demand + exchange demand. Reservation demand is your cash balance, i.e., the money in your current possession. Exchange demand is the goods and services you are willing and ready to exchange for money at the current price. It should be clear that total demand for money in the economy at any point in time is always constant for any fixed supply of money. It can never go up or down in the aggregate. Now obviously, the demand for money for individuals will vary and change in relation to many factors, one of them being the purchasing power of money.
Reservation demand vs exchange demand lead me to this pasage in man economy and state:
The total demand for money on the market consists of two parts: the exchange demand for money (by sellers of all other goods that wish to purchase money) and the reservation demand for money (the demand for money to hold by those who already hold it).
That’s good to know. So in the mystery of banking passage he seems to be talking about reserve demand–The mention of ‘how much money they would be willing to keep in their cash balances rather than spend.’ makes it seem that way to me.
Perhaps someone can clear this up this nagging confusion: If I am willing to keep X in cash balances rather than spend it, but in fact I only have Y in cash balances, and Y<X, is my reservation demand for money X or Y (or neither)?
What you are “willing” to keep (or buy) with the means (money) you don’t have is immaterial. I am also "willing’ to keep a million bucks in my bank account although I only have $1000. Make the distinction between wants and demand. Our wants are infinite while our demand is finite. Demand in the economic sense of the term implies having the means to make the exchange. So you cannot demand to hold X amount of cash when you only have Y. Your reservation demand for money is Y.
To expand on what DD5 said, an individual’s preferences are a ranking of the things he has against the things he might have if he were to exchange what he has for something he does not have. If I buy an orange for $1.39, that means that I prefer to have an orange more strongly than I prefer to have $1.39. The fact that I have a demand for cash balances, however, means that my demand for an orange (or anything else) is logically dependent upon the amount of money in my bank account. If I have $100 in the bank, I may be happy to part with $1.39 of it in order to have an orange. However, if only have $10 in the bank, even though I still have “enough” cash to buy the orange if I chose to, I may choose not to because my demand for $1.39 cash balance exceeds my demand for an orange costing $1.39.
I would be curious where Rothbard got this idea of reservation demand and exchange demand.