Quantity Theory of Money

12 Key excerpts on "Quantity Theory of Money"

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  Testing Monetarism

  • Meghnad Desai(Author)
  • 2013(Publication Date)
  • Bloomsbury Academic

    (Publisher)

  1. THE Quantity Theory of Money Monetarism as a word was coined around 1968 or 1969, 1 but as an idea it is clearly much older. Its origins can be traced back to the Quantity Theory of Money. As Friedrich Hayek said in a letter to The Times on 5 March 1980, 'The new fangled word monetarism means of course no more than the good old name Quantity Theory of Money, as it was formulated in modern times by the late Professor Irving Fisher and reformulated by Professor Milton Friedman.' The rudiments of the idea contained in the Quantity Theory of Money can be traced very far back, but perhaps the first modern treatment of it was by John Locke when he wrote on this as on many other matters. This makes the doctrine one of at least three hundred years' standing. This long lineage has been claimed as one of the arguments in favour of the quantity theory. As we shall see below, opposition to the quantity theory is an equally long standing tradition. There is also some evidence, not least that provided by Keynes in his 'Notes on Mercantilism' that there may be equally old roots to the argument that the rate of economic activity — the growth of prices and quantities determine changes in the stock of money rather than the opposite. This perhaps only shows that merits of one theory as against another cannot be decided by how old a theory is. 2 David Hume then formulated in his celebrated article 'Of Money' what would nowadays be called the homogeneity postulate: If the quantity of money in every citizen's pockets should double overnight, although trade may be stimulated in the short run, prices would eventually double. It seems a maxim almost self-evident, that the prices of everything depend on the proportion between commodities and money, and that any considerable alter-ation on either has the same effect, either of heightening or lowering the price. Increase the commodities, they become cheaper; increase the money, they rise in their value.

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  Monetary Economics

  Policy and its Theoretical Basis

  • Keith Bain, Peter Howells(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  The Quantity Theory of Money 57 Some versions of the theory did not require exact proportionality and admitted the possibility of a time lag between the increase in the money stock and the change in the price level. 2 The Quantity Theory is most familiar to modern readers through Fisher’s (1911) version in which it is approached through the equation of exchange: where M is the stock of money, P t T is the value of all transactions undertaken with money and V t , is the transactions velocity of money. We next assume that V t , T and M are all exogenous and can be taken as constant. We also assume that the monetary authorities can change the size of M at will. Then, causality runs from the supply of money to prices. We now have: This expresses the proposition that an exogenous increase in the quantity of money leads to a proportional increase in the price level and has no impact on real income (money is neutral). It is common to say that T is constant because the economy is making full use of all available resources (including labour). But we should note that this is not just a simple assumption that we can easily relax. The model accepts the classical view of a clear division between the monetary and real sectors of the economy. T is determined in the real sector and cannot be influ-enced by changes in M . In other words, money neutrality does not follow from the analysis of the role that money plays in an economy. Rather, the monetary sector is merely added on to an already-existing real sector and does not modify it in any way. Irving Fisher’s approach was more complex than this suggests since he distin-guished between transactions related to national income and those related to financial transactions: where Y and F are income and financial transactions respectively. If we accept this, and still require T to be exogenous and entirely unrelated to M , we must assume that financial transactions only take place in the pursuit of real ends.

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  Large Databases in Economic History

  Research Methods and Case Studies

  • Mark Casson, Nigar Hashimzade, Mark Casson, Nigar Hashimzade(Authors)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  3    The Quantity Theory of Money in historical perspective Nick Mayhew 3.1 Introduction

  This paper uses the Quantity Theory of Money (QT) to analyse price variations in England, 1270–1750. Prices play an important role in economic history, as noted in Chapter 2 . The price level is a key influence on the cost of living. For a given level of money wages, the price level determines what baskets of ordinary products a wage-earner can afford to purchase. The price level is measured by taking a weighted average of commodity prices, using weights that correspond to the amount of each commodity contained in a representative basket of goods. Each price is measured in terms of money. A price index constructed in this way measures the rate of exchange between real goods on the one hand and a unit of currency on the other.

  The money price level measures the scarcity of goods relative to the scarcity of money. It is therefore influenced by both the amount of goods that sellers bring to market, and the amount of money that buyers bring with them with which to purchase the goods. Prices can rise either because goods are in short supply or because money is in abundant supply. This is one of the basic insights of the QT.

  The QT was developed in response to practical problems of stabilising prices through management of the currency. One of the pioneers of the QT was the seventeenth-century English philosopher, John Locke. The sixteenth century witnessed a major debasement of the English currency by Henry VIII, and the seventeenth century witnessed further volatility, due in part to the English Civil War. A systematic formulation of the QT was developed in the early twentieth century, when it was formulated independently by Irving Fisher in the US and by Cambridge economists (Alfred Marshall and his followers) in the UK. The theory was challenged by John Maynard Keynes in the 1930s because he believed that a very rigid application on QT principles contributed to the persistence of unemployment during the Great Depression. Keynes proposed a more flexible version of the theory, but in the 1970s the Chicago economist Milton Friedman was influential in asserting its validity in the long run. Recently, however, some of Friedman’s claims have been challenged on the grounds that the relationship between money and prices is not so stable as he asserted.

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  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  The Quantity Theory of Money states that if the velocity of money is stable, or at least predictable, then the equation of exchange can be used to predict the effects of changes in the money supply on nominal GDP, P 3 Y. For example, if M increases by 5 percent and V remains constant, then P 3 Y, or nominal GDP, must also increase by 5 percent. For a while, equation of exchange The quantity of money, M, multiplied by its velocity, V, equals nominal GDP, which is the product of the price level, P, and real GDP, Y; or M 3 V 5 P 3 Y velocity of money The average number of times per year each dollar is used to purchase final goods and services Quantity Theory of Money If the velocity of money is stable, or at least predictable, changes in the money supply have predictable effects on nominal GDP Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 15 Monetary Theory and Policy 339 some economists believed they could use the equation of exchange to predict nominal output in the short run. Now, if at all, it’s used primarily as a rough guide in the long run. So an increase in the money supply results in more spending in the long run, mean- ing a higher nominal GDP. How is this increase in P 3 Y divided between changes in the price level and changes in real GDP? The answer does not lie in the quantity theory, for that theory is stated only in terms of nominal GDP. The answer lies in the shape of the aggregate supply curve. The long-run aggregate supply curve is vertical at the economy’s potential level of output.

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  Four Central Theories of the Market Economy

  Conception, evolution and application

  • Farhad Rassekh(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  Whatever may be the quantity of money in the country, only that part of it will affect prices, which goes into the market of commodities, and is there actually exchanged against goods. Whatever increases the amount of this portion of the money in the country, tends to raise prices. But money hoarded does not act on prices. Money kept in reserve by individuals to meet contingencies which do not occur, does not act on prices. The money in the coffers of the Bank, or retained as a reserve by private bankers, does not act on prices until drawn out, nor even then unless drawn out to be expended in commodities.

  Mill's expression of the quantity theory is as follows: “the quantity of money in circulation, is equal to the money value of all the goods sold, divided by the number which expresses the rapidity of circulation” (Ibid., p. 513).9 This is the equation of exchange that Ricardo had also expressed in words and, as we shall see in the next section, Alfred Marshall in 1871 translated into mathematics.

  Mill's analysis of the quantity theory in his Principles is reminiscent of his 1829 essay on Say's law in that he left for posterity a methodical and thorough description of a central theory in economics. Mill considered the quantity theory to be the foundation of monetary economics. He (Ibid., p. 514) wrote, “That an increase of the quantity of money raises prices, and a diminution lowers them, is the most elementary proposition in the theory of currency, and without it we should have no key to any of the others.”

  5 Alfred Marshall, Irving Fisher, and Knut Wicksell

  In 1871, two years before Mill died, Alfred Marshall wrote an important piece on the quantity theory titled, “Essay on Money.”10 In this essay Marshall based his analysis of the quantity theory on Mill's theoretical framework in chapters VIII and IX of the Principles of Political Economy

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  Essays in the Fundamental Theory of Monetary Economics and Macroeconomics

  • John Smithin(Author)
  • 2013(Publication Date)
  • WSPC

    (Publisher)

  itself (Patinkin, 1974; Leeson, 2003a, 2003b; Smithin, 2004a), or alternatively, that of Hicks (1982b). For a quantity theorist, however, the value of the approach would have been in rescuing the theory from its most obviously restrictive assumptions.

  To see the argument, write down the theory of money demand that was common to both “Keynesians” and “monetarists” in the version that appeared in 20th century textbooks:

  Equation (3.17) states that the demand for real money balances depends positively on real national income Y , and negatively on i, the nominal rate of interest. The first argument is what survives of Keynes’s “transactions demand for money” (Keynes, 1964/1936, p. 170), when translated into the “income version” of the quantity theory. The second is the opportunity cost of holding money, when money itself does not bear interest.6 This demand for money function leads directly to the “variable velocity” version of the quantity theory, which is:

  Equation (3.18) is just a specific functional form of (3.17). Next recall the relationship between the nominal interest rate, i, and the real interest rate, r:

  where pe stands for the expected inflation rate. Using this in the variable velocity quantity theory we arrive at:

  Putting things in this way allows for an argument that the quantity theory will still hold in equilibrium (also called the “steady-state”) even though, when out of the steady-state velocity can be changing.

  Note that if the model does converge to a steady-state equilibrium, expected and actual inflation will be equal at that point, pe = p. Also, by definition, the inflation rate itself must then have settled down to its equilibrium value (whether this is high or low), implying that dp /dt = 0. Finally recall that, according to monetarist theory, the real rate of interest is supposed to be fundamentally determined outside the money markets, by the “natural rate”. Therefore, in the steady-state r = rN and dr N

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  Macroeconomics without the Errors of Keynes

  The Quantity Theory of Money, Saving, and Policy

  • James C. W. Ahiakpor(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Robert Skidel-sky (1983: 214), Roger Backhouse (1985: 342), and David Laidler (1991: 123) are among those who have repeated Keynes’s charge without correction. In fact, determining the value of money from the classical Quantity Theory of Money is a direct application of the classical theory of value to money (currency), but through individual commodity markets, as in David Hume’s 1752 essay, “Of Money,” and argued by subsequent classical writers who followed him. The analy-sis arises from the use of money both as a unit of account (standard of value), by which individual commodity market prices represent the exchange ratios of money to units of commodities, and as a means of payment. Indeed, the “price level” is a weighted average of individual commodity prices, and there is no single market Keynes’s mistaken charge of a classical dichotomy regarding the Quantity Theory of Money 3 42 Keynes’s mistaken classical dichotomy on which it is determined by money’s supply and demand or by the supply and demand for output as a whole. The supply of money may derive from a single source, such as the mint or a central bank ( fi at money). But the quantity that is relevant for determining money’s value is the amount offered in exchange for com-modities in various product markets. Similarly, money’s demand derives from the quantity of commodities offered in exchange for it in various markets. Furthermore, contrary to Keynes (1936), the Quantity Theory explains that variations in the quantity of money affect relative product prices, interest rates, output, and employment in the short run. Keynes earlier had understood this from Marshall’s statements in evidence before the 1887 Gold and Silver Commission and the 1899 Indian Currency Committee (collected in Marshall 1926; see also Marshall 1923), and Keynes between 1912 and 1914 taught his undergraduate students the same (Keynes 1983: 693–4, 776–83).

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  The Golden Age of the Quantity Theory

  • David E.W. Laidler(Author)
  • 2014(Publication Date)
  • Princeton University Press

    (Publisher)

  They were referring, to put it in terms of Fisher's equation of exchange (which is discussed in Chapter 3), to the interaction of a flow of money expenditure (MV) and a flow of goods offered for sale - T rather than Y - and arguing that prices (P) had to move in order to reconcile these two largely independently determined flows. Mill puts the matter in the following way: As the whole of the goods in the market compose the demand for TRANSMISSION MECHANISM 17 money, so the whole of the money constitutes the demand for goods. The money and the goods are seeking each other for the purpose of being exchanged. They are reciprocally supply and demand to one another (1871, pages 509-10). To think about price level determination in this way had a number of consequences for classical monetary economics. To begin with, and as we have already seen, exponents of the classical quantity theory were much more willing than their modern successors to entertain the possibility that changes in velocity might be autonomous sources of price level variations in their own right. Although from the early eighteenth century onwards, just about everyone who wrote about the quantity theory argued that a change in the quantity of money would lead to a proportionate change in prices, the argument was usually accompanied by the explicit qualification that this prediction depended upon the assumption of a constant velocity of circulation, and the warning that this assumption did not usually hold in the real world. Mill was far from alone in defining the quantity of money relevant to the quantity theory as notes and coin in active circulation, excluding 'hoards' of such assets from the relevant aggregate. We have also seen how keenly aware were he and his contemporaries of the presence of other assets in the circulating medium, and the role of 'credit' in determining prices.

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  Money, Markets and Capital

  • Jean Cartelier(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  The propositions above are not to be discussed as such. They have been listed here only to clarify the intellectual context which gives its meaning to main-stream monetary theory. We should take that context as granted and we do not need to discuss or criticize it now. The most outstanding outcomes of value theory – determination of the rate of profit and prices of production for the Ricardo-Sraffa theory or existence of general competitive equilibrium prices and Pareto-optimality of these equi-libria for the Walras-Arrow-Debreu theory – are demonstrated in a moneyless economy. Money appears in value theory as a second thought. What economic theory tells us about economic relations (their essence or nature) is to be discovered less by examining the philosophical convictions of the theoreticians than by scrutinizing the assumptions necessary to the system Chapter 1 A bird’s-eye view 14 Money in value theory of equations whose relative prices are the solution. In the general competitive equilibrium theory of value – the one mainly considered here – relative prices reflect relative scarcities, i.e . equilibrium rates of marginal substitution between commodities. Economic theory deals with relative prices established for natural commodi-ties. Can it apply to money prices, which amounts to determining a price for money? Clearly it should be. Money exists and it must find room in value the-ory. Integration of money into value theory is the most traditional issue in standard monetary theory. Basically, this means that the system of equations designed for commodities should be extended to fiat money in order to determine its price (in terms of a numéraire ). The integration of money into value theory is considered to be achieved when fiat money is proved to have a positive price at equilibrium along with the other commodities in the general model. Classical (Sraffian) and modern general competitive equilibrium systems of equations leave no room for fiat money.

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  Nicholas Kaldor

  • J. King(Author)
  • 2008(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  (Kaldor 1939f, pp. 496–7) But Kaldor went much further than this: In fact, continued use of the MV PT type of equation (or of the n pk type), even when it is shorn of its wings, as in Professor Marget’s interpretation, is positively harmful rather than helpful. It engen- ders habits of mind which make one oblivious to some of the most fundamental modi operandi of economic forces. For people who are used to thinking in terms of these quantity equations it is extraordi- narily difficult to bear in mind such propositions as that a change in the quantity of money has (normally) no direct, but only an indirect, effect on the f low of money payments (the effect depending on a consequential change in the rate of interest and on the effect of this change on the scale of investments), or that the effect of a change in the f low of money payments is predominantly on the volume of goods sold, and not on prices, or that the level of prices is determined by the scale of money remunerations of the factors of production, and not by the f low of money payments. All these things are con- cealed, not exhibited, by the quantity equations. That Professor Marget himself is not entirely free from these habits of mind is shown by his choice of ‘The Theory of Prices’ as a title. ( ibid., pp. 497–8) I have quoted at some length from this rather obscure review of a rather obscure book because Kaldor’s attitude towards the Quantity Theory 138 Nicholas Kaldor was set out here more clearly than in any of his other (pre-1970) writ- ings. Money inf luences the economy only indirectly, through changes in the rate of interest. Changes in the money stock affect output and employment, not prices. The price level depends on the money wage rate, not on the stock of money. Throughout his life these were Kaldor’s principal objections to monetarism as an economic theory .

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  Marx's Theory of Money

  Modern Appraisals

  • F. Moseley(Author)
  • 2004(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Part III Marx’s Critique of the Quantity Theory of Money 143 9 Marx’s Explanation of Money’s Functions: Overturning the Quantity Theory Martha Campbell Marx’s account of the functions of money, I will argue, is simultaneously a critique of the quantity theory. This critique has three parts: it identifies the misconceptions that make the quantity theory false, explains why the the- ory seems obviously true and, last, presents an alternative explanation to replace it. On the first count, Marx argues that the quantity theory conflates different functions of money – measure and means of circulation – and dif- ferent forms – gold, tokens and credit money – and misconceives value as a result. Regarding the second, the quantity theory fits Marx’s definition of vulgar economics: the means of circulation function is immediately appar- ent and the quantity theory results from defining money in terms of it. Finally, Marx’s alternative to the quantity theory focuses instead on money’s function as means of payment, with the implication that capitalist money is credit money. This is the position of Tooke and his followers, with whom Marx so clearly sides in the Contribution. According to Marx, their refutation of the quantity theory is incomplete because they jumble both money with capital and money’s different aspects with each other. 1 Marx corrects the first of these defects by explaining money first in the context of simple circula- tion; he corrects the second by presenting money’s functions in the order in which they presuppose each other in capitalism. 1 Measure By the measure of value function Marx means that the value of every com- modity is expressed as a quantity of the money commodity or as price. His explanation of this function, therefore, spells out the characteristics of this expression or of the price form. Since Marx has dealt with the inter-connection between money and value before chapter 3 of Capital, he begins with two conclusions he has already reached.

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  Monetary Economics

  Theories, Evidence and Policy

  • David G. Pierce, Peter J. Tysome(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Other studies, concerned primarily with different issues, have also provided some evidence on the length of time lags, and this evidence will be mentioned in later sections. The general conclusion would appear to be that in the UK, monetary policy influences income with time lags that are both long and variable. Keynes versus the quantity theory in predicting macrovariables 175 1 - c 1 - c C= -± - + -^ -A 1 - c 1 - c C= ^ + ( -r ^ -^ A l -c l -c 7 (8.8) If we denote a/{l - c) by a, and (1/(1 - c) - 1) by β, then we have C = α + β>1 (8.9) Turning now to the simple Quantity Theory we have MV=Py = Y (8.10) where Μ is the supply of money and V is the 'money multiplier'. It is the stabihty and size of this multiplier that is important in assessing the usefulness of the Quantity Theory. In order to make a direct comparison with the Keynesian equation (8.9), however, Friedman and Meiselman did not in fact use equation (8.10) as the basis of their test of the Quantity Theory, but instead employed an equation with C as the dependent variable C = X + 6M (8.11) The money multiplier here is δ, and is not the same as the money multiplier V in equation (8.10), and does not bear any simple arithmetical relationship to it. From the crude Keynesian and Quantity Theory models, Friedman and Meiselman thus derived two different testable propositions. The Keynesian one was that C is primarily determined by A, while the Quantity Theory proposition is that C is primarily determined by M. This apparently simple dichotomy is shown as Causal Nexus 1 in Figure 8.2. Friedman and Meiselman, using data for the period 1897-1958, obtained correlation coefficients for each of equations (8.9) and (8.11) and for variants of those equations, both for the data period as a whole and for a variety of sub-periods. Consistently the results showed a higher correlation between C and Μ than between C and A, the one exception being for the sub-period 1929-35.

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