## Models of money demand

8.2.1 The velocity of circulation

Models of the velocity of circulation are derived from the ‘equation of exchange’ identity often associated with the quantity theory of money (Fisher 1911) which on logarithmic form can be written:

mt + vt = pt + yt, (8.1)

where mt is money supply, vt is money velocity, yt is a scaling variable (e. g. real output), and pt is the price level. We define the inverse velocity of money as mt — yt — pt = – vt (small letters denote variables in logarithms). A simple

theory of money demand is obtained by adding the assumption that the velocity is constant, implying that the corresponding long-run money demand relationship is a linear function of the scaling variable yt, and the price level pt. The stochastic specification can be written as:

mt – yt – pt...

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