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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

Which of the following is the main criticism that Keynesians make of the simple quantity theory of money?

Keynesians argue velocity is not stable because people's demand for money depends on interest rates and expectations. Extra money may be held as idle balances, so changes in money supply do not reliably translate into proportionate changes in prices.

  1. AMoney supply cannot be measured in any economy
  2. BVelocity may be unstable because the demand for money depends on interest rates, so the link from money to prices is not reliableCorrect
  3. COutput is always determined by the money supply
  4. DInflation can only be caused by wage rises
  5. Prices never respond to excess demand

Explanation

Keynesians argue that liquidity preference makes money demand, and so velocity, sensitive to interest rates and expectations. Hence changes in money supply may alter velocity rather than prices. The other options misstate either Keynesian or classical views.

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