Every community sought to provide a medium of exchange in order to allocate resources efficiently. Every society has resources that are allocated to people, and this is achieved by a structured currency such as money. The societies needed to value goods and services in order to determine the reward for capital and labor. There was a need to solve the problem of perishable goods by adopting a currency that does not expire. Therefore, every society needed to establish a medium of exchange, store of value and a unit of account (Wray, 2012).
The 1930s Bank failure, resulted from a decrease in money multiplier; as the public and banks hold more money, the money multiplier decreases. The public was worried that if the banking system collapses, they will lose their money. The banks feared that if they lend too much, they might collapse. Lower money multiplier was the cause of bank failure (Krugman & Wells, 2006).
People hold money for transitory purposes, speculative purposes and precautionary purposes. Transitory purposes are money demanded to meet the daily transaction needs such as purchases and payment of utility bills. Speculative demand is money demanded to speculate over investment opportunities that may arise. Money for precautionary purposes is demanded to meet emergencies and unforeseen emergency expenditures. Therefore, the demand for money is speculative, transitory and precautionary purposes (Wray, 2012).
According to Krugman and Wells (2006), the velocity of money is a measure of the mean frequency of the expenditure of a unit of money in an economy. It is calculated as follows:-
Gross Domestic Product = Velocity of Money x Money supply