A note on the demand for money

Abstract

This paper attempts to clear up a common confusion in the literature centering around the demand for money. It will be shown that the current literature confuses an excess demand for or supply of money in the foreign exchange market with an excess demand for or supply of domestic cash balances. 1 The following statement by Cleveland and Brittain illustrates this common confusion [Cleveland and Brittain, 1976, pp. 20-1] : "There is a measure of truth in singling out hedging or speculation against the dollar as a source of world inflation. Such speculative flows did enlarge the monetary base and the money supply in European countries, as well as in Japan. In fact, inflows of dollars, partly speculative in character, were responsible for much of the inczease in other industrial countries' monetary bases in the year 1970-73 . . . . But, it is a different question whether the inflows caused the money supply and price inflation in these countries to be greater than they otherwise would have been. Monetary theory suggests that this was probably not the case. Inflation occurs when there is an excess of money supply over the demand for money. The inflows of funds occurred in response to a new, speculative demand for marks. Thus, it was the increase in demand for marks that gave rise to the increase in the supply of marks; therefore, the inflows could not have created or contributed to creating an excess of mark money supply over demand. How, then, could they have raised German prices above the level they otherwise would have reached?" From the above we may infer that because Germans and others were acquiring marks, they must have had an excess demand for holdings of them. However, for example, German firms that had been borrowing dollars abroad wanted to convert these dollars to marks on the foreign exchange market. There was an excess demand