Keynesian monetary theory

John Maynard Keynes questioned the quantity theory of money and said that it not is certain that the price level is directly dependent on the money supply.

Keynes argued that there could be unemployment in the economy so that Q in the equation is changing instead of P when the money supply changes. Keynes also argued that one must take the interest rate into account, when the money supply increases, the interest rate falls, leading to increased investments and demand for goods. How much prices rise depends on the interest rate sensitivity of demand for goods. This criticism led to the development of the keynesian monetary theory.

Keynesian monetary theory was developed in the early 1900s and assumes that it is the supply and demand for money that determines the interest rate and the interest rate sensitivity of the demand for goods that determines the price level. In keynesian monetary theory, there are three reasons why there is demand for money, transaction motive, speculative motive and the precautionary motive.