Quantity theory of money

In Economic scenes, the quantity theory of money is a economic Théorie based on the relation of causality between the quantity of currency in circulation and the general Niveau of the prices (i.e., an increase in the money Supply will involve a rise of the prices).

This theory was developed by various authors in various countries. We can quote, among them, Jean Bodin at the 16th century. She was reformulated by the theories monetarists during the years 1970 in a restrictive version to tackle the theories keynésienne S. the monetary theories are opposed on the role of the currency in the economy. The traditional and neo-classic consider that the currency is neutral, the keynésiens affirm that the currency is active and that it can be used to improve the economic performances, and the monetarists think that the currency is active, but especially harmful in the economy.

Definition

The first formulation of the quantity theory of money goes up with work of Jean Bodin in 1568. Its work concerned the inflationary effects of the arrival of gold coming from the New World.

The traditional ones formalized the following quantitative theory:

$M * V = P * Q$

$Q$ is the production of an economy for a given period,
$P$ is the price level,
donc $P*Q$ represents the quantity of money which was exchanged
$M$ is the quantity of currency in circulation in an economy for this same period.
$V$ is the speed of circulation of the currency, i.e. the number of times that the same unit of currency makes it possible to regulate transactions for the period considered.

$Q$ and $P$ are Vecteur S; $M$ and $V$ can also be simple numbers, in the simplest formulation, but as there exist different type of currency (ticket, coins, accounts - checks, marketable securities, etc) which circulate at different speeds, one can also treat them like vectors, or Irving Fisher (1911) to limit itself to two types of currency:

$M_1 * V_1 + M_2 * V_2 = P * T$

The speed of circulation and the distribution of the currency between different the types belong to the elements taken into account by the monetarists in the estimates of the health of an economy. In the short run, its value is regarded as stable, function of the behaviors of Thésaurisation and the methods of payment (liquid, check, credit card) of the economic agents.

Implications

According to the monetarists, the speed of circulation of the currency ( $V$ ) is constant. In the same way for the level of production ( $T$ ) which is supposed to be constant because of situation of full employment of the factors of production in the economy. According to these two assumptions, any increase in the quantity of currency ( $M$ ) involves a raising of prices ( $P$ ). That leads the monetarists to think that inflation is only one purely monetary phenomenon. If there is inflation in an economy, it can be due only to one excessive monetary creation compared to the level of production of the country.

The restrictive assumptions are disputed by many economists. Nowadays, the quantity theory of money is commonly allowed long-term, which is not the case in the short or medium term. According to the theory of Jean-Baptiste Say, the currency would be only one veil , i.e. the real sphere of the economy would be separated from the monetary sphere. The currency would not have any effect on the level of production of an economy (traditional dichotomy).

Speed of circulation of the currency

Calculation

The calculation the speed of circulation of the currency V requires to know for one period T the quantity M of currency available and the amount P of the richnesses created for this period (typically, a GDP). P and M must be in the same unit.

$V = \ frac {P*Q} {M}$

With knowknowing

The Liquidity ratio is equal contrary the speed of circulation of the currency, that is to say 1/v.

Empirical value

In the Euro area, the GDP was into 2006 of 8378 billion euros whereas the money Supply m3 was, it, of 7788 billion euros. The speed of circulation thus was of 1,08.

The value the speed of circulation increased since 1980.

The value does not have a limited raison d'être, it can be higher or lower than 1.

When one spends of the money, one does not have it any more, it could thus seem logical that if Wikipédiens of 2012 have 25.000 ψ, they cannot spend more than 25.000 ψ, therefore the speed of circulation of the currency should be 25/25, that is to say 1. This reasoning forgets the element which is at the base of the Monétarisme: when a unit of currency is spent by a Economic agent, this one inevitably will not keep this currency for him, but itself will spend about it whole or part, and while thus passing from agent in agent, this currency will make it possible to create richness again on the one hand and will return to that which spent it on the other hand.

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