Monetary Equilibrium


Abstract: One implication of the concept of monetary equilibrium is that the money supply should vary with money demand. In a recent paper, Bagus and Howden (Rev Austrian Econ 24:383–402, 2011) argue that this conclusion is predicated on the assumption of price stickiness. The purpose of this paper is to suggest that the foundation of monetary equilibrium is the role of money as a medium of exchange. As such, changes in the demand for money result in changes in both nominal and real spending that are welfare-reducing. This proposition is then used to examine whether a monetary policy in which the central bank varies the money supply in response to money demand can be considered optimal. In addition, the paper considers how a free banking system with competitive note issuance would vary the money supply in response to changes in money demand. In both cases, the results are consistent with the concept of monetary equilibrium. In addition, these results can be obtained even when prices are perfectly flexible if trade is decentralized (i.e. not conducted in Walrasian markets). Price stickiness is therefore not a necessary condition to suggest that the money supply should vary with money demand.