The Supply of Money and the Dynamics of Adjustment

Abstract

If the monetary base is not controlled by the monetary authorities, it might appear that the stock of money simply responds to the demand for it. This has indeed been the argument that has usually been put forward; it is, however, incorrect. It is a view which depends crucially on the existence of continuous equilibrium in money markets. It is argued in this chapter that the demand for and supply of money are determined independently of each other, even when the monetary base is endogenous, and that we need to take account of the existence of disequilibrium. The idea that there can be disequilibrium in money markets is not a new one, and Friedman and Meiselman’s description of money as a residual store of purchasing power can be interpreted in this light. Macroeconomics has, however, been dominated by static-equilibrium models, in particular the IS/LM model. This chapter provides the description of an alternative money-supply process which has direct implications for modelling the rest of the economy. The supply mechanism is therefore described within the broad outline of a dynamic model of the economy.