Quantity Theory of Money

Discipline: Economics

Developed by the Americans SIMON NEWCOMB (1835-1909) and Irving Fisher (1867-1947), the latter of whom's original equation stated in simple terms that the amount of money in circulation equals money national income; that is,


where M is money stock, V is velocity of circulation, P is average price level and T the number of transactions. The equation assumes that the velocity of circulation of money is stable (at least in the short term) and that transactions are fixed by consumer tastes and the behavior of firms.

Quantity theory of money was superseded by Keynesian analysis. Members of the Cambridge School were concerned with the volume of money held given the number of transactions carried out. They argued that the greater the number of transactions, the greater the amount of money held. English economist Arthur Cecil Pigou (1877-1959), in particular, asserted that the nominal demand for money was a constant percentage of nominal income.

In the Cambridge Equation, PT is replaced by Y (the income velocity of circulation). The equation is:

V = Y / M

where M is money stock in economy, Y income velocity of circulation and V average velocity of circulation.

Monetarists argue that an increase in prices would not lead to inflation unless the government increased the money supply.

Also see: commodity theory of money, monetarism

S Newcomb, Principles of the Political Economy (New York, 1885);
I Fisher, The Purchasing Power of Money (New York, 1911);
M Friedman, ed., Studies in the Quantity of Money (Chicago, 1956)


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