Monetising the Classical Equations: A theory of circulation

Abstract

The Classical Equations describe output and income in real terms. To use them to analyse aggregate demand, the transactions they describe must be 'monetised'. A sum of money equal to the wage bill of the capital goods sector can be shown to be necessary and sufficient to carry out all transactions, in a process of circulation which also defines an expression for velocity. When money has intrinsic value, the quantity approach may hold in the short run but, in the long run, money will be endogenous. In these conditions, the rate of interest will be determined by the supply and demand for reserves, but when money is purely nominal, only a minimum rate will be fixed, and the rate of interest will have to be pegged. The Appendix develops the Classical Equations and shows that they define an invariable unit of account. © Cambridge Political Economy Society 2004; all rights reserved.