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Quantity Theory Of Money

  The quantity theory of money, in economics, is the foundation stone of monetarism. This theory maintains that the level of prices in a country is determined by the quantity of money in circulation. It was developed into an equation by Irving Fisher (1867 - 1947) as MV = PT, where M is the money supply, V is its velocity of circulation, P is the price level, and T is the volume of transaction in goods and services. If V is constant and T changes very little over a short period of time, then the price level (P) depends upon the money supply (M). Other economists, such as Alfred Marshall and Milton Friedman, have developed their particular versions of the quantity theory of money.

Critics argue that V is neither constant nor predictable and that T can change in critical amounts in short periods of time. A second dispute is that even if there is a link between M and P, it need not be a causal link, still less one that leads from money to prices.

These controversies have raged since the 1930s, when Keynesians began to challenge the orthodoxy represented by the quantity theory. The theoretical debate has been supplemented by a mass of empirical research into the value of V and into the timelag between changes in M and changes in P. Modern monetarists recognize that the relationship is complicated but continue to hold that the quantity of money is key to controlling the price level and the level of economic activity in the longer run; Keynesians believe that they are vindicated. The argument continues. TF

Further reading Milton Friedman, Studies in the Quantity Theory of Money; , J.M. Keynes, The General Theory of Employment, Interest and Money.



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