Dr.

Shivani Mohan
QUANTITY THEORY OF MONEY Assistant Professor of Economics
C.N.L.U., Patna
MONEY AND ITS SIGNIFICANCE
“Anything is generally acceptable as a means of
exchange and that at the same time acts as a measure
and as a store of value”.
-Crowther

“Money is what Money does”.

F.A. Walker
The idea of determination of value of money by the supply of money (15th century)
First developed by Irving Fisher in United States
Modified by Cambridge Economists in 20th century
Reinterpreted by Keynes and Patinkin
Restated by Friedman
QUANTITY THEORY OF MONEY

Quantity Theory of Money was first Propounded in

1588 by an Italian Economist, Davanzati.

John Locke formulated the Theory (attempted to explain

the rise in prices in Europe).

Theory was elaborated by David Hume in 1752.

It is none of the wheels of trade: it is the oil which renders the motion of the wheels
more smooth and easy”
 Quantity Theory of Money

Irving Fisher Cambridge Economist

Milton Friedman
(Medium of Exchange) (Store of Value)
Cash Transaction Approach Cash Balance Approach (Restatement)

Marshall

Pigou

Keynes

Robertson
FISHER’S CASH TRANSACTION APPROACH
Irving Fisher in his book “The Purchasing Power of Money” in 1911 gave equation
“Other things remaining unchanged, as the quantity of money in circulation increases,
the price level also increases in direct proportion and the value of money decreases
and vice versa.”
MV=PT

M=amount of money in circulation in given period of time

V= velocity of the money
P=general price level
T=volume of trade or transaction
ASSUMPTION AND CRITICISMS
ASSUMPTIONS
1.P is inactive element(Price will not influence money supply)
2. V is assumed to be constant
3. T is also constant
4. Long - run analysis
CRITICISMS
1. Price level depends upon many other factors like Consumption habits, central bank policy
etc.
2. money’s role is confined to transaction approach only
3. Prices may not rise despite increase in the quantity of money during depression
4. it neglects the role of the rate of interest as one of the causative factors between money and
prices
5. Neglects store of value function.
CAMBRIDGE CASH-BALANCE APPROACH-KEYNESIAN ANALYSIS
Keynes- A Tract on Monetary Reform (1923) gave Real Balance Approach
Improvement over Cambridge Equation
Keynes- people always want to have some purchasing power to finance their day to day
transactions.
The amount of purchasing power(demand for money) = tastes habits + wealth
Desire to hold money (Demand for money) = taste+ habits+ wealth
Demand for money is measured by consumption units
Consumption Units=(Basket of standard articles of consumption)
Consumption Units in cash =k
Total currency in circulation= n
Price for consumption unit=p
 CONTD..
Equation
n=pk
Or p=n/k
if k is constant, a proportionate increase in n (Quantity of money)
will lead to proportionate increase in price level p.
(Keynes considers the equation superior to other cash balances equations ,
other equation fails to address how the price can be regulated.)
n = p(k+rk’)
p = n/(k+rk’)
r-Ratio of banks’ cash reserves to their deposits
k’-number of consumption units the community decides to hold in the form of
bank deposits.
Taking into account bank deposits. If
k’= number of consumption units in the form of bank deposits
r = the cash reserve ratio of banks, then expanded equation is
n = p(k+rk’) or
p = n/(k+rk’)
r-Ratio of banks’ cash reserves to their deposits
k’-number of consumption units the community decides to hold in the form of bank deposits.
since cash balances (k) held by the public are outside the control of monetary
authority, p can be regulated by controlling (n) and (r)
Also to regulate bank deposits k’ appropriate changes can be done in bank rate
Therefore, p can be controlled by making appropriate changes in n, r and k
CRITICISMS
1. P measures only price level of consumption goods while money is used for vast
number of goods (business and personal)

1. In short run relationship between n and p is not direct, n cause changes in k, k’

and r
 MILTON FRIEDMAN: RESTATEMENT OF QTM
Economic agents (individuals, firms, governments) want to hold a
certain quantity of real, as opposed to nominal, money balances
“Quantity Theory of Money –A Restatement” –1956
“Monetary Trends in the United States and United Kingdom” -
1982
Milton Friedman (1890–1963) Wealth can be held in five forms
•Money –Currency, Demand Deposit and Time Deposits.
•Bonds –interest payments that are fixed in nominal units.
•Equities –dividend payments that are fixed in real units.
•Physical Goods or non-human goods are inventories of producer
and consumer durable.
•Human Capital is the productive capacity of human beings.
 CONTD..
It is the modern version of the classical QTM
M=ƒ (Y, W, P, , , )
M=aggregate demand for money
Y=total flow of income
W=ratio of non-human to human wealth
P=price level
U =utility determined variables which tend to influence tastes and preferences
,= market bond interest rate
, =equity yields
,= expected rate of change of prices of commodities
CONCLUSIONS AND CRITICISMS
Rise in the expected yields on different forms of asset reduces the amount of money
demanded by a wealth holder
Increase in wealth raises the demand for money
Criticisms
More importance to wealth definition
Very Broad definition of Money
Thank You!