Patinkin Money theory

Patinkin money theory. In his theory he Criticizes classical quantity theory of money and balance approach. He introduce " Real balance effect"

1. Monetary theory Topic: Patinkin’s monetary theory Supervisor: dr. Waqqas Qayyum By: Rashid nasir Reg : 756-se/ mseco /f23 School of economics International Islamic university Islamabad

2. Table of contents Classical Quantity Theory of Money (QTM ) Cambridge Cash-Balance Approach : Money Market Good Market What Is Real Balance Effect Patinkin’s Real Balance Effect Explained Real Balance Effect on Aggregate Demand Don Patinkin theory Assumptions

3. Don Patinkin, in 1956 Quantity theory of Money Engaged in a critical examination of both the Classical Quantity Theory of Money (QTM) and the Cambridge Cash-Balance Approach Classical Quantity Theory of Money ( QTM) Classical QTM often assumed a constant velocity of money. Patinkin argued that this assumption is unrealistic because velocity can change due to various economic factors. Patinkin criticized the classical economists for neglecting the real balances effect. He argued that changes in the real supply of money (adjusted for changes in the price level) can influence real economic activity.

4. The Classical QTM often didn't explicitly consider the role of interest rates in determining the demand for money. Patinkin highlighted the importance of interest rates in influencing money demand . Classical economists assumed full employment in their models. Patinkin argued that this assumption was unrealistic and that variations in the level of employment should be considered in the analysis. Cambridge Cash-Balance Approach : Patinkin criticized the Cambridge economists for not distinguishing clearly between the transactions demand for money (for facilitating transactions) and the real balances effect (the desire to hold money for its own sake). He argued that the Cambridge approach did not adequately address the income elasticity of money demand. Changes in income can affect the demand for money, and this should be incorporated into the analysis.

5. Patinkin emphasized the importance of liquidity preference in determining the demand for money. He argued that the Cambridge approach needed to incorporate the speculative motive for holding money, as proposed by John Maynard Keynes. Cambridge economists were criticized for not providing a dynamic analysis of how changes in the money supply affect the economy over time. Patinkin advocated for a more dynamic approach to monetary theory .

6. Don Patinkin 1956 sought to reconcile the money market and the goods market through the concept of the real balance effect. This reconciliation is a key aspect of his analysis of the Quantity Theory of Money (QTM ). Money Market: In the money market, individuals decide how much of their wealth to hold in the form of money. This decision is influenced by the nominal interest rate. As the money supply increases, the nominal interest rate tends to fall . Goods Market : In the goods market, individuals decide how much to consume and how much to save. The real balance effect comes into play here. An increase in the money supply leads to a higher level of real balances (the purchasing power of money) for individuals. This increase in real balances affects their consumption decisions.

7. The real balance effect Real balance effect is also known as "Patinkin effect" is developed by Jewish economist Don Patinkin by published a well-known book titled "Money, Interest and Price" in 1956 . Don Patinkin states that an increase in the amount of money in the economy first affects the demand and relative price levels and then the absolute prices .

8. Patinkin’s Real Balance Effect Explained Real balance.’ In an economy, it refers to the purchasing power of the public or the money ( stock of money) with them Hence, Patinkin disproved the quantity theory using the real balance effect. It states that as the money supply increases, the demand and price levels for goods and services and the absolute economical prices increase . Patinkin believed that price level influences the real balance, thus affecting the demand . Therefore, the effect has facilitated the integration of monetary, real, and  labor markets .

9. Real Balance Effect On Aggregate Demand Firstly, an increase in real balance contributes to purchasing power. This leads to an increase in  consumer spending ; thus, demand for goods and services will go up. To satisfy increased demands, supply will have to rise too . Hence, employment will increase, and demand for labor will drive up wages. This, in turn, increases the money stock with people as more and more people are employed A nother cycle is set, where public money increases trigger a demand-induced price hike. Over time, the high prices will reduce the purchasing power of the people. So demand falls, along with general price levels and, consequently, employment rates.

10. Comparative Statics and Real Balance Patinkin presents a comparative-static analysis of the equilibriums corresponding to two different nominal quantities of fiat money. we write equations for equilibrium in the markets for the four groups into which all exchangeable items are aggregated commodities(including services), labor, bonds, and money. Y0 = full-employment output of commodities ( that is, full-employment real income ). P = price level. W = money wage rate. r = interest rate M0 = exogenously given initial nominal quantity of money .

11. The following are the equations ： F ( Y0 , M /P, r ) = Y0 Commodity equilibrium Nd ( W /P ) = Ns ( W /P ) Labor equilibrium Bd ( Y0 , M /P, r ) = Bs ( Y0 , M /P, r ) Bond equilibrium PL ( Y0 , M /P, r ) = M0 Money equilibrium

12. If the four equations are satisfied for quantity of money M0, price level p0, wage rate w0, and interest rate r0, then, when the quantity of money is multiplied by k and becomes kM0, the equations are satisfied at price level, wage rate and interest rate of kp0, kw0 and r0. In the new equilibrium, prices and wages have changed in the same proportion as the quantity of money and the interest rate is unchanged.

13. Don Patinkin theory Assumptions: It is assumed that an initial equilibrium exists in the economy, that the system is stable, that there are no destabilizing expectations and finally there are no other factors except those which are specially assumed during the analysis .   It is assumed that there are no distribution effects, that is, the level and composition of aggregate expenditures are not affected by the way in which the newly injected money is distributed   It is also assumed that there is no money illusion. Thus, Patinkin has discussed the validity of the quantity theory only under conditions of full employment, as according to him Keynes questioned its validity even under conditions of full employment.

14. In Patinkin’s approach we reach the same conclusion as in the old quantity theory of money but we employ modern analytical framework of income-expenditure approach or what is called the Keynesian approach. In other words, Patinkin has rehabilitated the truth contained in the old quantity theory of money with modern Keynesian tools . Thank You Sir!