Patinkin real balance effect

Patinkin real balance effect - Demand for Money - Post Keynisian Demand for Money

1. PATINKIN REAL BALANCE EFFECT R.SENTHAMIZH VEENA BHARATHIDASAN UNIVERSITY TAMIL NADU

2. PATINKIN REAL BALANCE EFFECT Don Patinkin – work – “Money, Interest and Prices” Criticises Cambridge economists for homogenetity and Dichotomisation Reconciles through real balance effect

3. The homogeneity hypothesis states that the demand and supply of goods are pretentious only by relative prices. It means that a doubling of money prices will have no effect on the demand and supply of goods. Therefore this homogeneity hypothesis precludes the price level from affecting the goods market as well as the money market.

4. Patinkin criticises this hypothesis for its failure to have any determinate thesis of money and prices. Another closely related presumption which Patinkin criticises is the discrimination of the goods and money in the neo-classical study. This dichotomisation means that the relative price level is determined by the demand and supply of goods Absolute price level – dd & ss of money .

5. Similar to the homogeneity hypothesis, this presumption also implies that the price level has completely no effect on the monetary segment of the financial system and the level of monetary prices in turn has no effect on the real segment of economy. After reproaching the neo-classical presumptions outlined above, Patinkin puts together the money market and the goods market which is based not only on relative prices but also on real balances.

6. Real balances mean the real purchasing power of the stock of cash holdings of the people . When the price level changes, it affects the purchasing power of people’s cash holdings which in turn, affects the demand and supply of goods. This is the real balance effect Patinkin denies the existence of the homogeneity hypothesis and the dichotomisation presumption through this effect.

7. Thus the DD for commodity depends on both real balance and relative prices as well If price level ↑ - real balance(purchasing power) ↓ - spend less – DD for goods ↓ - prices ↓ price decline – value of money ↑ - DD for goods ↑

8. Diagrammatic explanation

9. The real balance effect is represented diagrammatically by using the IS and LM technique for the reason that the IS curve represents the goods market and the LM curve the money market . To start with we take a condition when the economy is in equilibrium at OY1 level of earnings when the IS and LM curves interconnect at point A where the interest rate is Or1.

10. Presuming OYF as the full employment level Current employment – y1 Therefore unemployment Y1 – YF Certain level of unemp leads to ↓in prices and wages ↑ in real value of money holding Shift in LM cure to LM1 It intersects the IS curve at point B – income level OY2 - the interest rate drops to Or0 which inspires investment, discourages savings and enhances consumption.

11. Even when the interest rate drops to its minimum level Or0 the level of demand in the commodity market as represented by the IS curve is not high enough to lead the economy to the full employment level OYF. Rather, y2 – yf level of unemp exists tends to a further drops in wages and prices and to the hike in demand for consumption goods which transfers the IS curve to the right to IS1 so that it overlaps the LM1 curve at point C at the full employment level OYF.

12. Thus under conditions of wage and price flexibility when the IS and LM curves shift rightwards, the real balance effect ultimately leads the economy to full employment level THANK YOU