1. The document discusses various theories related to the quantity theory of money, including the Fisher Identity and the Cambridge Cash Balances equation.
2. It analyzes the components and assumptions of these theories, such as the transactions demand for money being proportional to aggregate transactions.
3. Criticisms of the older quantity theories are presented, including that they assumed full employment and an exogenously determined money supply, whereas Keynes argued resources are often underemployed and the money supply is endogenous.
1) Statement to Quantity Theory of Money
2) Graph illustration and Pictorial description of QTM
3) Different Approaches to QTM
4) Fisher's Transaction Approach Description
5) Assumptions of Fisher's Transaction Approach
6) Conclusion
In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply. The theory was challenged by Keynesian economics,but updated and reinvigorated by the monetarist school of economics. While mainstream economists agree that the quantity theory holds true in the long run, there is still disagreement about its applicability in the short run. Critics of the theory argue that money velocity is not stable and, in the short-run, prices are sticky, so the direct relationship between money supply and price level does not hold.
Alternative theories include the real bills doctrine and the more recent fiscal theory of the price level.
1) Statement to Quantity Theory of Money
2) Graph illustration and Pictorial description of QTM
3) Different Approaches to QTM
4) Fisher's Transaction Approach Description
5) Assumptions of Fisher's Transaction Approach
6) Conclusion
In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply. The theory was challenged by Keynesian economics,but updated and reinvigorated by the monetarist school of economics. While mainstream economists agree that the quantity theory holds true in the long run, there is still disagreement about its applicability in the short run. Critics of the theory argue that money velocity is not stable and, in the short-run, prices are sticky, so the direct relationship between money supply and price level does not hold.
Alternative theories include the real bills doctrine and the more recent fiscal theory of the price level.
Quantity Theory Of Money
Velocity Of Money & Equation Of Exchange
Determinants of Velocity
Demand For Money
The Classical Dichotomy
Quantity Theory & Price Level
Quantity Theory & Inflation
Money: Definition, Origin, Functions, Inflation, Deflation, Value of Money, M...flowerpower_1324
These slides cover the first chapter of the B.Com "Banking and Finance" syllabus: Money.
It includes the following topics: Definition, Origin, Functions, Inflation and its remedies, , Deflation and its causes, reflation, devaluation, , Monetary and Fiscal Policy, Paper Money: its kinds and advantages and disadvanatges, Monetary system, Value of Money: quantity theory of money, cash balance approach, modern theory of money.
Quantity Theory Of Money
Velocity Of Money & Equation Of Exchange
Determinants of Velocity
Demand For Money
The Classical Dichotomy
Quantity Theory & Price Level
Quantity Theory & Inflation
Money: Definition, Origin, Functions, Inflation, Deflation, Value of Money, M...flowerpower_1324
These slides cover the first chapter of the B.Com "Banking and Finance" syllabus: Money.
It includes the following topics: Definition, Origin, Functions, Inflation and its remedies, , Deflation and its causes, reflation, devaluation, , Monetary and Fiscal Policy, Paper Money: its kinds and advantages and disadvanatges, Monetary system, Value of Money: quantity theory of money, cash balance approach, modern theory of money.
This standalone presentation was originally created in INTE 6710 at the University of Colorado Denver. It has since been modified to better fit the needs and culture of my organization.
Hey guys, here is my presentation on most sought after query on career for both teachers and students. Designed for a Missionary School, hope this presentation helps you out.
Regards
Sunita :)
Are fiscal/monetary conditions affecting the macro thesis for Canadian farmland investments? Do publicly traded equity investments hedge all inflation regimes? Canada's debt to GDP - looming threat or irrelevancy?
10Trade DeficitsCauses andConsequencesDavid M. Go.docxpaynetawnya
10
Trade Deficits:
Causes and
Consequences
David M. Gould
Senior Economist and Policy Advisor
Federal Reserve Bank of Dallas
Roy J. Ruffin
Research Associate
Federal Reserve Bank of Dallas
and
M. D. Anderson Professor of Economics
University of Houston
For the most part, trade deficits
or surpluses are merely a reflection
of a country’s international
borrowing or lending profile
over time. …Neither one, by itself,
is a better indicator of long-run
economic growth than the other.
On September 19, 1996, the Washington
Post, Wall Street Journal, and New York Times
reported trade figures released by the U.S. De-
partment of Commerce showing that the monthly
U.S. trade deficit increased by $3.5 billion in July
1996. Almost unanimously, analysts quoted in
the articles stated that the recent trade figures
showed weakness in the U.S. economy. The
news was not earth shattering, nor was the
interpretation of the increasing trade deficit con-
troversial. The conventional wisdom is that the
trade balance reflects a country’s competitive
strength —the lower the trade deficit, the greater
a country’s competitive strength and the higher
its economic growth.
But the conventional wisdom on trade bal-
ances stands in stark contrast to that of the
economics profession in general. Standard eco-
nomic thought typically regards trade deficits as
the inevitable consequence of a country’s pref-
erences regarding saving and the productivity of
its new capital investments. Trade deficits are
not necessarily seen as a cause for concern, nor
are they seen as good predictors of a country’s
future economic growth. For example, large trade
deficits may signal higher rates of economic
growth as countries import capital to expand
productive capacity. However, they also may
reflect a low level of savings and make countries
more vulnerable to external economic shocks,
such as dramatic reversals of capital inflows. Is
the conventional wisdom wrong, or has the
economics profession just failed to keep its
theories well-grounded in fact?
Certainly, anyone can create a theory about
trade deficits and speculate about how they
may, or may not, be related to a nation’s eco-
nomic performance. The paramount question is
not whether one can create a theory, but whether
it is logically consistent and stands up to em-
pirical observation.
The purpose of this article is to answer the
question of whether trade deficits, bilateral as
well as overall, are related to a country’s eco-
nomic performance. We begin by discussing the
origin of popular views on trade deficits and
compare these views with current economic
thought on trade balances. Next, we discuss the
relationship between international capital flows
and trade balances and relate them to economic
growth. We then empirically examine the rela-
tionship between trade deficits and long-run
economic growth.
The evolution of ideas about trade balances
The mercantilists. Much of the current
popular thinking on trade balance ...
1- Consider the model of liquidity and financial intermediation presen.docxfitzlikv
1. Consider the model of liquidity and financial intermediation presented in class. The economy has an infinite horizon and is populated by a large number of individuals who each live for three periods. In period t there are N t individuals born where N t = n N t 1 and n 1 . Individuals receive utility from consuming in middle age and when old. That is, individuals have utility function U ( c 2 , t + 1 , c 3 , t + 2 ) = ln c 2 , t + 1 + ln c 3 , t + 2 where ( 0 , 1 ) . For simplicity you can assume that n = 1 and = 1 . Individuals have one unit of time that is supplied inelastically as labor, but possess different productivities denoted by [ 0 , 1 ] . An individual with productivity produces units of the consumption good when young. Assume that the productivity of the young generation is uniformly distributed over the interval [ 0 , 1 ] in every period. There is a risk-neutral bank takes deposits and commits to a one-period return denoted by r d , so that one unit of the consumption good deposited with the bank yields the gross return r d units of the consumption good in t + 1 . When an individual withdraws from the bank, they pay a fixed cost > 0 , measured in units of the consumption good. This fixed cost has many interpretations including the annual fee on a deposit account or the time required to go to a bank (or bank machine) to withdraw (in fact during COVID-19 you could also consider the risk associated with making an in-person withdrawal as a component of this fixed cost). Individuals have three stores of value available; fiat money ( m ) , deposits ( d ) , and capital ( k ) . There is a supply of fiat money available in period t denoted by M t , where M t = z M t 1 for all t where z 1 . Capital has a two period return X > n 2 and a one-period return x = X 1/2 , however, unmatured capital cannot be sold, traded or borrowed against. For parts (a) - (d) you can assume that the real rate of return on fiat money in a stationary equilibrium is n = 1 , and the return on deposits satisfies r d ( n , x ) , where x = X 1/2 . Further for parts (a) - (e) you can assume that the money supply is constant so that z = 1 and M t = M for all t . Please answer the following questions and assume a stationary equilibrium (i.e. c 2 , t ( ) = c 2 ( ) for all t and c 3 , t ( ) = c 3 ( ) for all t ) . (a) Write down the utility maximization problem of a type worker including all budget constraints. Explain how individuals in the economy will use money, deposits and capital. (b) Write down the Lagrangian and solve for the optimal choices of capital, deposits, real money and consumption for any type individual. If it is easier, you an solve the problem by considering a type w worker and doing the following: (i) Assume the bank does not exist so that individuals do not make deposits and can only use fiat money and capital. Solve for the equilibrium levels of consumption ( c 2 , t + 1 and c 3 , t + 2 ) , capital ( k t ) , and individual real money demand ( t m t.
The French Revolution, which began in 1789, was a period of radical social and political upheaval in France. It marked the decline of absolute monarchies, the rise of secular and democratic republics, and the eventual rise of Napoleon Bonaparte. This revolutionary period is crucial in understanding the transition from feudalism to modernity in Europe.
For more information, visit-www.vavaclasses.com
Instructions for Submissions thorugh G- Classroom.pptxJheel Barad
This presentation provides a briefing on how to upload submissions and documents in Google Classroom. It was prepared as part of an orientation for new Sainik School in-service teacher trainees. As a training officer, my goal is to ensure that you are comfortable and proficient with this essential tool for managing assignments and fostering student engagement.
Students, digital devices and success - Andreas Schleicher - 27 May 2024..pptxEduSkills OECD
Andreas Schleicher presents at the OECD webinar ‘Digital devices in schools: detrimental distraction or secret to success?’ on 27 May 2024. The presentation was based on findings from PISA 2022 results and the webinar helped launch the PISA in Focus ‘Managing screen time: How to protect and equip students against distraction’ https://www.oecd-ilibrary.org/education/managing-screen-time_7c225af4-en and the OECD Education Policy Perspective ‘Students, digital devices and success’ can be found here - https://oe.cd/il/5yV
This is a presentation by Dada Robert in a Your Skill Boost masterclass organised by the Excellence Foundation for South Sudan (EFSS) on Saturday, the 25th and Sunday, the 26th of May 2024.
He discussed the concept of quality improvement, emphasizing its applicability to various aspects of life, including personal, project, and program improvements. He defined quality as doing the right thing at the right time in the right way to achieve the best possible results and discussed the concept of the "gap" between what we know and what we do, and how this gap represents the areas we need to improve. He explained the scientific approach to quality improvement, which involves systematic performance analysis, testing and learning, and implementing change ideas. He also highlighted the importance of client focus and a team approach to quality improvement.
Ethnobotany and Ethnopharmacology:
Ethnobotany in herbal drug evaluation,
Impact of Ethnobotany in traditional medicine,
New development in herbals,
Bio-prospecting tools for drug discovery,
Role of Ethnopharmacology in drug evaluation,
Reverse Pharmacology.
Synthetic Fiber Construction in lab .pptxPavel ( NSTU)
Synthetic fiber production is a fascinating and complex field that blends chemistry, engineering, and environmental science. By understanding these aspects, students can gain a comprehensive view of synthetic fiber production, its impact on society and the environment, and the potential for future innovations. Synthetic fibers play a crucial role in modern society, impacting various aspects of daily life, industry, and the environment. ynthetic fibers are integral to modern life, offering a range of benefits from cost-effectiveness and versatility to innovative applications and performance characteristics. While they pose environmental challenges, ongoing research and development aim to create more sustainable and eco-friendly alternatives. Understanding the importance of synthetic fibers helps in appreciating their role in the economy, industry, and daily life, while also emphasizing the need for sustainable practices and innovation.
2024.06.01 Introducing a competency framework for languag learning materials ...Sandy Millin
http://sandymillin.wordpress.com/iateflwebinar2024
Published classroom materials form the basis of syllabuses, drive teacher professional development, and have a potentially huge influence on learners, teachers and education systems. All teachers also create their own materials, whether a few sentences on a blackboard, a highly-structured fully-realised online course, or anything in between. Despite this, the knowledge and skills needed to create effective language learning materials are rarely part of teacher training, and are mostly learnt by trial and error.
Knowledge and skills frameworks, generally called competency frameworks, for ELT teachers, trainers and managers have existed for a few years now. However, until I created one for my MA dissertation, there wasn’t one drawing together what we need to know and do to be able to effectively produce language learning materials.
This webinar will introduce you to my framework, highlighting the key competencies I identified from my research. It will also show how anybody involved in language teaching (any language, not just English!), teacher training, managing schools or developing language learning materials can benefit from using the framework.
How to Create Map Views in the Odoo 17 ERPCeline George
The map views are useful for providing a geographical representation of data. They allow users to visualize and analyze the data in a more intuitive manner.
Palestine last event orientationfvgnh .pptxRaedMohamed3
An EFL lesson about the current events in Palestine. It is intended to be for intermediate students who wish to increase their listening skills through a short lesson in power point.
1. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
MODERN QUANTITY THEORIES OF MONEY: FROM
FISHER TO FRIEDMAN
Most economic historians who give some weight to monetary forces in European economic history
usually employ some variant of the so-called Quantity Theory of Money. Even in the current economic
history literature, the version most commonly used is the Fisher Identity, devised by the Yale economist
Irving Fisher (1867-1947) in his book The Purchasing Power of Money (revised edn. 1911). For that
reason we cannot avoid it, even though most economists today are reluctant to use it without significant
modification.
1. The Fisher Identity, or The Equation of Exchange: M.V = P.T
M = stock of money in coin, notes, bank deposits ('high-powered')
V = the velocity of circulation; the rate at which a unit of money circulates in effecting transactions in
course of one year; the average number of times it 'turns over'
P = some measure of the price level; e.g. Consumer Price Index
T = the total volume of monetary transactions that take place in the economy during the course of that
same year.
a) This is more of an identity () or tautology than it is a causal equation: it simply states that total
spending, in terms of the money stock multiplied by the rate of its turnover or circulation, necessarily
equals total spending in terms of the total volume of monetary transactions multiplied by the current
price index. The two values on each side of the sign are necessarily identical.
b) Problems with the Fisher Identity:
i) M and P, it has been argued, are extremely difficult to estimate or calculate. For the medieval, early
modern, modern, and present day eras this is a form of nitpicking that in no way invalidates the model.
Good proxies can be provided for most of these eras, certainly good enough to indicate general
movements of both prices and monetary stocks. The other two objections are far more important.
ii) T really is quite impossible to calculate for any period or even to comprehend. That is, even if we
could attach a numerical value to T, it would be rather meaningless: T = the total volume of all
transactions in the economy, both intermediate and final, from raw materials to fully manufactured
products along with all services. How can we resolve the problem of multiple counting? How can we add
up all the transactions involving so many different commodities and services: with what common
denominator? Adding together apples and oranges (as pieces of fruit) is a very simple task by
comparison.
iii) V, as a measure of the velocity of circulation or turnover of money, is not in fact an independent
variable, but rather a residual one, which has to be calculated algebraically by first knowing the other
three. Thus we can calculate V only by this formula: V = (P.T)/M
2. The Cambridge Cash Balances Equation: M = k.P.T
2. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
This is a lesser-known rival to the Fisher Identity that emerged during the 1920s at Cambridge, with a
formula that resolved at least the problems concerning Velocity:
a) Its originators at Cambridge (especially A.C. Pigou) asked two principal questions:
(1) how much 'high-powered' money (usually called M1), do people currently wish to hold in the form of
cash balances (money held in coin, notes, bank deposits), rather than being spent or invested?
(2) What, therefore, is the ratio of those cash balances to the total money value of all transactions in the
economy?
b) That ratio is indicated by the letter k; and this form of the Quantity equation now becomes: M =
k(P.T). The letter k thus indicates the proportion of the total value of all monetary transactions that the
public chooses to hold in cash balances; and thus it tells us the necessary amount of M that is required
for that level of P.T (total spending). Note that P times T again equals the total monetary value of all
transactions; and thus suffers from the same problems of estimating the value of T, as indicated above
for the Fisher Identity.
c) Liquidity Preference: a concept further developed by Keynes, who asked a fundamental question.
Why do people wish to hold cash balances, instead of immediately spending or investing that money?
He suggested three motivations.
(1) transactions motive: people hold a stock of ready cash in order to meet their day to day needs in
buying goods and paying for services, etc. This is deemed to be the major need for holding ready cash.
(2) precautionary motive: to have ready cash on hand in order to meet some unforseen emergency, as a
contingency fund for future needs.
(3) speculative motive: to have ready cash to take immediate advantage of some special investment
opportunity -- a cash fund to speculate with.
d) Cash Balances and Opportunity Cost:
What is the cost of holding these cash balances? The true cost is the opportunity cost: i.e. the interest or
other investment income foregone by not investing those balances. Consequently, we should find that
cash balances are to some extent interest-sensitive, and vary with interest rates. That is, the proportion
of national income held in cash balances (k) should fall as real interest rates rise, because rising interest
rates will increase the opportunity cost of holding those balances; and conversely that proportion k held
in cash balances should rise with falling real interest rates.
e) Note that mathematically, the Fisher and Cambridge Cash Balances equations are related: k is the
reciprocal of V; V is the reciprocal of k
f) What is the difference between k and V?
3. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
Why is k a more useful variable than V? Because k is much more 'predictable;' and conceptually k is an
'active' variable -- i.e. we should be able to predict roughly what proportion of total national
expenditures people wish to hold in cash balances. But V, on the contrary, is a passive (i.e. resulting
from) or 'residual' variable, calculated as noted only by first knowing M, P, and T. Thus one might say
that k (cash balances) is a predictive measure of velocity, while V measures only resulting velocity.
3. The Basic Suppositions Concerning the Older Quantity
Theories of Money
a) The Demand for Money is chiefly a TRANSACTIONS DEMAND:
b) The Transactions Demand for Money will be proportional to the aggregate value of transactions (i.e. k
as proportion of P.T); and this proportion will not vary in the short run;
c) The Supply of money is exogenously determined, determined independently of the economy (by
some external authority or events).
d) Full Employment prevails: so that any increase in aggregate demand will not increase the volume of
output or transactions (T);
e) Those with excess money will spend it on goods and services; those with insufficient supply of money
will cut their expenditures on goods and services.
f) The Transactions Velocity of Money is, at least in the short run, very stable.
4. The Modern Form of the Quantity Theory: Friedman's
Income Version
a) While the Cambridge cash balances approach apparently resolved the problem of V, it did not resolve
the quite intractable problem of T. Modern economists, however, have more or less resolved that
problem by ignoring the total volume of transactions, and by looking instead at the Net National Income
or the aggregate of net national expenditures.
b) To understand this, we can begin with the Gross National Product or its equivalent, the Gross
National Income: as the total current money value of all final goods and services produced in the
economy in a given year. From that dollar amount we deduct a sum for 'depreciation' (for depreciation
of worn out, wasted capital stock) in order to arrive at Net National Product. Thus, just as Gross National
Product (GNP) = Gross National Income (GNI), so Net National Product (NNP) = Net National Income
(NNI), which is represented here by the capital letter Y. That letter Y will be familiar to anyone who has
studied at least the rudiments of Keynesian economics:
Y = C + I + G + (X - M).
That is, Net National Income (Y) equals the sum of total national Consumption (C) plus total Investment
(I) plus Government Expenditures (G) plus the net difference between total Export incomes (X) and total
expenditures on Imports (M).
c) Since this value Y is usually expressed in terms of current dollars, we must now express that net
national income in dollars of unchanging values, i.e. in what are called 'constant dollars' that reflect a
constant or stable purchasing power, which has been adjusted for inflation (thus the term: 'deflated net
national income'). That value of a deflated NNI, or 'real NNI,' or 'net national income in constant dollars,'
4. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
is expressed by lower-case y. Upper-case Y of course measures NNI in current dollars, which currently
has meant a declining purchasing power, because of inflation.
d) This new value y or real NNI is obviously much more measurable than T. To
calculate y: divide Y by P. That is, calculate the NNI by deducting depreciation from the GNP; and then
divide that result (NNI) by some agreed upon price index (e.g. consumer price index): y = Y/P.
For example: the value of the Gross Domestic Product in the 2nd quarter of 1991 was $683.64 billion
(just 1.8% higher than the corresponding figure for 1990. Divide that amount by the GDP Price Index
(whose base is 1986 = 100), which is 121.8 -- i.e. meaning that this price index is 21.8% higher than the
weighted average of prices for all items in the price basket for 1986. The result (divided by 1.218) is
$561.3 billion, which is the 'real' GDP for 1991 in constant 1986 dollars. (This amount is
1.75% lower than the corresponding figure for 1990, $571.33 billion). Unfortunately the data currently
available are for GDP only, not for NNP; and these GDP data will have to serve as proxies for Y and y.
e) So, by using that 'y' value to express constant or deflated net national income (NNI), in place of
unmeasurable T, in the two quantity theory equations, those Fisher and Cambridge equations now
become:
i) Fisher: M.V = P.y
Thus V measures the income velocity of money: the rate at which a unit of money circulates in
producing total net national income (or net national expenditures or net national product).
ii) Cambridge Cash Balances: M = k.P.y or, M = kPy
Thus k measures the proportion of aggregate national income that the population collectively holds in
cash balances.
iii) While the Cambridge version is conceptually preferable, it is mathematically related to the much
more widely used Fisher equation, or better the modern income version of that equation (k = 1/V). So
you will presumably also prefer to use it: but at least please use it in this modernized form: M.V =
P.y [MV = Py]
f) What factors affect V and k?
i) Any changes affecting those three elements of liquidity preference: for the transactions,
precautionary, and speculative demands for money.
ii) Changes in population: population structures, market structures, transaction costs, etc. requiring that
a greater or smaller proportion of national income be held in cash balances.
iii) Changes in financial instruments: many of which economize on the use of money, coined money, and
so speed up the effective velocity of coinage
iv) Supply shocks: effects of famine, war, war financing, etc; sudden increases in the supply of food, fuel,
etc.
v) Predictions about the future value of money: i.e. a form of 'rational expectations:' if you believe that
in the future money will lose its purchasing power, you will get rid of it, i.e. exchange it for assets of
more stable value: and thus reduce cash balances and increase money velocity.
vi) Interest rates and levels of national income:
5. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
5) Keynesian Criticisms of the Quantity Theories of Money:
i) While quantity theorists believe that k or V are stable, at least in the short run, Keynes and his
followers believe(d) that these variables are highly unstable and volatile.
(1) in particular, they argue that k and V are highly sensitive to interest rates in the short run, which in
turn are functionally related to changes in the money supply. In short, Velocity varies inversely with the
money supply and directly with interest rates; alternatively, that k varies directly with the money supply
and inversely with interest rates. Remember that the interest rate represents the opportunity cost of
holding cash balances.(1)
(2) Thus, in the short run at least, an increase in the money supply M should lower interest rates, which
in turn should reduce Velocity (or permit a rise in k). Furthermore, a more plentiful money supply
reduces the need to economize on the use of money, thus also reducing Velocity (or encouraging larger
cash balances).
ii) While quantity theorists have looked upon the aggregate money supply (continental or world --
depending on the era) as largely exogenous, Keynesians have considered it to be largely endogenous,
and a function of the real factors determining production and trade.
iii) The classic Quantity Theory of Money, as noted earlier, assumed a normal or equilibrium state of Full
Employment, meaning that all resources would be fully employed, so that any increase in monetized
spending would have to drive up prices proportionally, since any further increase in production and
trade was impossible (in the short run). Keynes, writing during the Great Depression years, argued that
underemployment of resources was more often the normal state; and that an increase in monetized
spending would induce the productive employment of further resources, resulting in an increased
output and trade that would counteract any potential inflation from that increased spending.
iv) Keynes on longer-term inflation: In criticizing the classical Quantity Theory of Money, he stated: 'So
far, we have been primarily concerned with the way in which changes in the quantity of money affect
prices in the short period. But in the long run is there not some simpler relationship? This is a question
for historical generalisation rather than for pure theory...' [The General Theory of Employment, Interest,
and Money (1936), p. 306.]
v) Observations:
(1) Can we assume such perfect elasticity of response of V or k to changes in M and to changes in
interest rates: Would an historian, usually studying somewhat 'longer runs' than those assumed by
economists, believe that V or k would always change in exact proportion to changes in M, over long
periods of time?
(2) We may deal with that question by assuming that, to the extent that changes in V or k are not exactly
proportional to the changes in M, the difference is taken care of by increases in production and trade,
i.e. by the changes in y. But again the historian may doubt that all the changes -- in M, V or k, and y -- are
always so neatly counterbalancing, so that P (the price level) remains stable.
(3) We may agree that the money supply, especially for any given region or country, is far more
endogenous than was assumed by the classical Quantity Theory; and that changes in real factors,
changes in investment, production, and trade, may well induce necessary changes in the money supply,
especially if the money supply is heavily based on credit instruments. But what about a pre-modern
money supply that is far more based on precious metals? Are changes in the supply of precious metals
and in mint outputs so fully endogenous in the Keynesian sense? Furthermore, what about coinage
debasements: what determines them?
(4) In summary, supposing that the money supply was essentially endogenous, one may argue that the
various economic processes increasing y (NNI) -- e.g. population growth, technological changes,
investment, changing foreign trade patterns -- induced the requisite monetary expansion: in M, or in V,
6. MACRO ECONOMICS BY KHALID AZIZ
IQRA COMMERCE NETWORK: SIR KHALID AZIZ
0322-3385752/0300-2540827
or in both together. If, however, inflation also occurred (a rise in P), historians must then explain why
the evident monetary expansion was greater than the rise in real output and real incomes: why, with P,
(M.V) y.
(5) The following section develops this theme; but to make the argument perfectly clear and to ensure a
logical flow, many of the points made in this series of observations are necessarily repeated.
QUANTITY THEORY OF MONEY
The Quantity Theory of Money seeks to explain the factors that determine the general price level in a
country. The theory states that the price level is directly determined by the supply of money. There are
two versions of the Quantity Theory of Money: (1) The Transaction Approach and (2) The Cash Balance
Approach. Let us discuss them in detail.
The Transaction Approach (Fisher):
Fisher’s transaction approach to the Quantity Theory of Money may be explained with the following
equation of exchange.
MV = PT
Where, M is the total supply of money
V is the velocity of circulation of money
P is the general price level
T is the total transactions in physical goods.
This equation is an identity, that is, a relationship that holds by definition. It means, in an economy the
total value of all goods sold during any period (PT) must be equal to the total quantity of money spent
during that period (MV). Fisher assumed that (1) at full employment total physical transactions T in an
economy will be a constant, and (2) the velocity of circulation remain constant in the short run because
it largely depends on the spending habits of the people. When these two assumptions are made the
Equation of Exchange becomes the Quantity Theory of Money which shows that there is an exact,
proportional relationship between money supply and the price level. In other words, the level of prices
in the economy is directly proportional to the quantity of money in circulation. That is, doubling the
total supply of money would double the price level.
It may be noted that the above Fisher’s Equation include only primary money or currency money. But
modern economy extensively uses demand deposits or credit money. It was on account of the growing
importance of credit money that Fisher later on extended his equation of exchange to include credit
money.
Fisher’s Transaction Approach can explain the causes of hyperinflation that occurs during war or
emergency. It can also explain certain long term trend in prices. But it cannot explain normal peace time
inflation. This shortcoming has been modified by the Cambridge version or the Cash-Balance Approach.
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The Cash-Balance Approach (Cambridge): The Cash-Balance Approach to the Quantity
Theory of Money may be expressed as:
p = kR/M …………………………(1)
where p = the purchasing power of money
k = the proportion of income that people like to hold in the form of money;
R = the volume of real income; and
M = the stock of supply of money in the country at a given time.
This equation shows that the purchasing power of money or the value of money (p) varies directly with k
or R, and inversely with M.
Since p is the reciprocal of the general price level; that is p = 1/P, the equation, p = kR/M can be
expressed alternatively as:
1/P = kR/M ……………………..........(2)
or M = kRP ………………………...(3)
If we multiply the volume of real income (R) by the general price level(P), we have the money national
income(Y). Therefore,
M = kY …………………………….........(4)
where Y is the country’s total money income. We can also write equation (3) in terms of the general
price level thus:
P = M/kR ………………………...........(5)
This equation implies that the price level (P) varies inversely with k or R and directly with M.
In the Cash Balance approach k was more significant than M for explaining changes in the purchasing
power (or value) of money. This means that the value of money depends upon the demand of the
people to hold money.
SUPERIORITY OF THE CASH BALANCE APPROACH
The Cash Balance approach to the Quantity Theory of Money is superior to the Transaction Approach on
the following grounds.
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1. The Transaction approach emphasizes the medium of exchange function of money only. On the other
hand, the Cash Balance approach stresses equally the store of value function of money. Therefore, this
approach is consistent with the broader definition of money which includes demand deposits.
2. In its explanation of the determinants of V, the Transaction approach stresses the mechanical aspects
of the payments process. In contrast, the Cash Balance approach is more realistic as it is behavioral in
nature which is built around the demand function for money.
3. As to the analytical technique, the Cash Balance approach fits in easily with the general demand-
supply analysis as applied to the money market.
This feature is not available in the Transaction approach.
4. The Cash Balance approach is wider and more comprehensive as it takes into account the income
level as an important determinant of the price level. The Transaction approach neglected income level
as the determinant of the price level.
5. According to the Transaction approach, the change in P is caused by change in M only. In the Cash
Balance approach P may change even without a change in M if k undergoes a change. Thus k, according
to the Cash Balance approach is a more important determinant of P than M as stressed by the
Transaction approach.
6. Moreover, the symbol k in the Cash Balance approach proves to be a better tool for explaining trade
cycles than V in Fisher’s equation.