The equation for money demand expressed in the chapter that is derived from the equation of exchange is:Md = PYWe see that the equation does not explicitly address the interest rate. In fact, Professor Fisher assumed that velocity is constant which means 1/V is also a constant. Why do you think Professor Fisher left the interest rate out of the equation? Do you think he would if he were alive today? Explain.

Question

What will be an ideal response?

Answer 1

Professor Fisher made two assumptions, one was velocity (V) was determined by institutional structures that would not change quickly and that the real output of the economy (Y) was determined by economic inputs and the production function. Basically then, Professor Fisher must have assumed the only plausible role for money was for transactions, he never viewed or he dismissed the speculative or wealth (portfolio) holding roles for money. This might make sense if he thought that since money holdings do not earn interest that people would never hold more money than what was needed for transactions since they would not want to give up any interest that they otherwise could have earned. If Professor Fisher were alive today, he certainly would be interested in the short term volatility of velocity and he would likely view the 1/V as something other than a constant, realizing that velocity of money can be influenced by interest rates.