He integrated the two theories through the rate of interest. The proper monetary policy is to allow the money supply to grow in line with the growth in the country’s output. Why does price level change? Thus, any change in the supply of money (M) will have no effect on T. Constancy of T also means full employment of resources in the economy. It regards the velocity of money to be constant and thus ignores the variation in the velocity of money which are bound to occur in the long period. Privacy Policy 9. (ii) In Figure 1-B, when the money supply is doubled from OM to OM1; the value of money is halved from O1/P to O1/P1 and when the money supply is halved from OM to OM2, the value of money is doubled from O1/P to O1/P2. Definition: Quantity theory of money states that money supply and price level in an economy are in direct proportion to one another.When there is a change in the supply of money, there is a proportional change in the price level and vice-versa. On the other hand, if the quantity of money is reduced by one half, the price level will also be reduced by one half and the value of money will be twice. Disclaimer Copyright, Share Your Knowledge 2. The velocity of money depends upon exogenous factors like population, trade activities, habits of the people, interest rate, etc. Welcome to EconomicsDiscussion.net! 2. First, the quantity theory of money for its unrealistic assumptions. Fisher assumes a proportional relationship between currency money (M) and bank money (M’). Thus, the quantity theory of money fails to explain the trade cycles. Fisher’s quantity theory of money is explained with the help of Figure 1. Since, consumer spending and business spending decisions depend upon relative prices; changes in the money supply do not affect real variables such as employment and output. Fisher’s quantity theory of money is explained with the help of Figure 1. A number of historical instances like hyper- inflation in Germany in 1923-24 and in China in 1947-48 have proved the validity of the theory. It implies that changes in the money supply are neutral in the sense that they affect the absolute prices and not the relative prices. Constant Volume of Trade or Transactions: Total volume of trade or transactions (T) is also assumed to be constant and is not affected by changes in the quantity of money. Content Guidelines 2. Economics, Money, Theories, Fisher’s Quantity Theory of Money. Money is neutral. The quantity theory of money does not discuss the concept of velocity of circulation of money, nor does it throw light on the factors influencing it. The quantity theory of money was put in the form of an equation of exchange by Fisher. Abstract. Keynes recognised the stores of value function of money and laid emphasis on the demand for money for speculative purpose as against the classical emphasis on the transactions and precautionary demand for money. Fisher’s equation of exchange is related to an equilibrium situation in which rate of interest is independent of the quantity of money. (iii) P Influences T – Fisher assumes price level (P) as a passive factor having no effect on trade (T). (iv) Under the equilibrium conditions of full employment, the role of monetary (or fiscal) policy is limited. Fisher has explained his theory in terms of his equation of exchange: where P = price level, or 1/P = the value of money; M = the total quantity of legal tender money; T = the total amount of goods and services exchanged for money or transactions performed by money. Account Disable 12. According to Keynes, “So long as there is unemployment, output and employment will change in the same proportion as the quantity of money, and when there is full employment, prices will change in the same proportion as the quantity of money.” Thus Keynes integrated the theory of output with value theory and monetary theory and criticised Fisher for dividing economics “into two compartments with no doors and windows between the theory of value and theory of money and prices.”. The quantity theory does not explain the cyclical fluctuations in prices.