Abstract

Friedmans money demand function is neither derived in his own writings nor elsewhere in the literature. The portfoliotheoretical foundations of his money demand function have remained in the dark. The present analysis intends to eliminate this shortcoming. Special attention is given to an explicit capitaltheoretical derivation of the rate of return of the various assets. The portfoliotheoretical analysis leads to a generalization of Friedmans money demand function that is empirically relevant. Compared with Friedman it also includes a more realistic definition of equities. The analysis demonstrates the special assumptions with respect to the behaviour of relative prices of goods and services that underly Friedman’s formulation of the money demand function. Due to these assumptions some distinguishing elements of the monetarist relative price theory are unnecessarily excluded from his money demand function. Thus Friedmans formulation of the money demand function appears not to be consistent with his ideas about the transmission mechanism of monetary impulses on economic activity.