In Volume I of this book, we ignored the fact that people have a demand for money as well as for the goods that they use their money to buy. But people want to hold money to pay for their day-to-day transactions, and holding money incurs an opportunity cost measured by the return people could receive by using their money to buy interest-earning assets. Let’s call these assets “bonds.”
We can begin our discussion of the demand for money with an identity:
where M is the stock of money, V is the turnover rate of money, P is the price level, and Y is real income. In a fiat money system, money, having no intrinsic value, depends ...
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