Question

1. Discuss the quantity theory of money.
2. Make a case against Monetarism.

Answer 1

The definition of the theory of quantities of money (QTM) originated in the 16th century. When gold and silver inflows from the Americas into Europe were minted into coins, inflation rose as a result. This development led economist Henry Thornton to assume in 1802 that more money is equal to more inflation, and that an increase in the supply of money does not necessarily mean an increase in economic production. Here we look at the assumptions and calculations underlying the QTM, as well as its monetarist relationship and how the theory was challenged. Money theory of quantities states that there is a direct relationship between the amount of money in an economy and the price level of goods and services sold. According to QTM, when the amount of money in an economy rises, price rates often increase, causing inflation (the percentage rate at which price levels in an economy are rising). Consequently the consumer pays twice as much for the same amount of the good or service.

QTM applies assumptions to the exchange-equation rationale. The theory assumes, in its most basic form, that V (circulation velocity) and T (transaction volume)are constant over the short term. However, those assumptions were criticized, particularly the assumption that V is constant. The arguments point out that the speed of circulation depends on the impulses of consumer and business spending which can not be constant. The theory also suggests that the amount of money determined by external forces is the principal factor of economic activity in a society. Changing money supply results in price-level changes and/or a decrease in the supply of goods and services. It is these shifts in money supply that are largely triggering a shift in spending. And the velocity of circulation does not depend on the amount of money available, or the current price level, but on price level adjustments.

Monetarism is based on the Quantity Theory of Money. The principle is an ideology of accountants— that is, it has to be valid. This means that velocity-multiplied money supply (the rate at which money changes hands) is equal to nominal economic expenditure (the amount of goods and services sold multiplied by the average price paid for them). That equation is uncontroversial, as an accounting concept. What's controversial here is speed. Monetarist theory considers velocity to be generally stable, meaning that nominal revenue is largely a function of money supply. Nominal income variations reflect changes in real economic activity (number of goods and services sold) and inflation;

Long-term monetary neutrality: an increase in the money stock would be accompanied by an increase in the overall price level in the long run, with no effect on real factors such as demand or output.- Short-run monetary nonneutrality: an increase in the money stock has temporary effects on real output (GDP) and short-run jobs, as wages and prices take time to adjust (they are)

Most monetarists often think that in the absence of significant unforeseen changes in the money supply, economies are inherently stable. They also assert that government intervention can often more than help destabilize the economy. Monetarists also assume that there is no long-term correlation between inflation and unemployment, because the economy settles in a long-term balance at a full level of production jobs