Quantity Theory of Money
Candlefocus EditorQTM is based on the concept that the amount of money in an economy affects the overall level of prices, known as inflation. The amount of money in an economy is determined by the central bank, which creates money by buying and selling government bonds. This money circulates through the economy at different rates, depending on a variety of economic factors.
At its most basic level, the QTM states that an increase in the money supply will lead to an increase in the price level. This is because an increase in the money supply increases the demand for goods and services, resulting in prices rising to meet this new level of demand. On the other hand, if the amount of money in an economy decreases, the price level will eventually fall.
QTM has been historically studied and explained by many influential economists including Irving Fisher, John Maynard Keynes, Knut Wicksell, and Ludwig von Mises. Fisher’s early work on the QTM focused on its direct relationship between the money supply and the overall price level. Keynes and Wicksell each had their own particular version of the QTM, which were more dynamic and thought to better capture the complexity of the economic environment. The newer work done by von Mises sought to integrate the views of Keynes and Wicksell while also incorporating a more economic approach to the QTM.
The QTM has been subject to significant debate and criticism in the past. Many economists believed that it was overly simplistic and did not take into account additional factors such as economic growth, technology and global competition. Further, some argued that it did not account for the liquidity preference of people. This means that people may prefer to hoard money as a store of value instead of spending it, which would reduce the impact of money supply on prices.
Despite its critics, the QTM remains a powerful tool used to explain and predict the behavior of economies. Central banks around the world use it to manage their economies, by manipulating the money supply to shape the level of inflation. Private sector analysts also apply the theory to inform their forecasting on the economic outlook and investment strategies. Ultimately, the theory remains an important part of macroeconomic study and analysis.