Quantity Theory of Money Equation: Definition & Meaning
In this little guide, we’re going to talk about quantity theory. Let’s see. You know the idea that money changes as the supply changes, right? Well, this is actually described in technical terms as quantity theory. Is it a legit “rule”? No. It’s actually a hypothesis, but we’ll get into that later. There are many factors that affect the quantity theory of money, and that’s why we’re going to try to get more in depth about it. Monetarists (economists who strongly believe in quantity theory of money) fully believe that the quantity theory of money affects almost every aspect of business as well. They also think that the health of an entire economy can literally be operated based on the changes that affect monetary supply, either by ruling or regulating it, like the government for example.
What is Monetarism?
This practice is actually kind of a lifestyle, and a train of thought, that shows that high inflation is caused by raising the money supply at a faster rate than the money’s actually created. If the money supply is being fully used and controlled as well as regulated on distribution, the economy will literally be self-efficient. They believe that the more transactions that are done in the economy are equal to the money supply and circulation. When there’s more money available, you’ll get more transactions, purchases, and services bought with money. However, when the money supply is short, the price level of all goods actually lowers, as well as the amount of transactions for the said amount. They believe that this is one of the things that affects the general thought of the quantity theory of money’s equation causes the price fluctuations that affect everyone, but still leave the businesses on top for success.
Is the QTM (quantity theory of money) Real?
There are some people who contradicted the theory, and as the theory was challenged with some solid results to back it up, certain monetarists, including the founder of the theory, Irving Fisher, had to do what they had to in order to prove that Friedman, an exemplary monetarist who didn’t challenge this theory at all in his success, can affect certain factors, as well as increase purchases made and transactions made or the velocity of the money movement, regardless of how much was available.
What has been found is that the Quantity of Money doesn’t always follow everything. But a good example that can be found is how things changed after September 11, of 2001. The way prices of fuel increased above levels as more money came into circulation, and more. It ended up causing inflation in the economy as people got more money funded from the government. The downside is that the money was borrowed, so while we had more money in circulation, the price of everything greatly started to increase. Even today, a soda that would normally be seventy-five cents back in 2000, now costs an average of two dollars.
How to Briefly Explain QTM
The QTM rule states that quantity of money and economic levels as well as the prices of things that were sold to consumers. When the amount of cash doubles, inflation is caused because the price levels increase by doubling as well, since there is more of a supply of money. When there is more of a shortage, there is a drop in prices so they can compensate for the lower amount of transactions that are made, and the velocity of movement can either remain stationery or slow down.
This makes money more of any other form of commodity, because it operates on the supply and demand just like the good and services available to consumers do. Which is why it can fluctuate the same.
How the Theory is Calculated
The Fisher Equation is that Money Supply multiplied by Velocity of Circulation equals the Average Price Per Level and the Volume of Transactions of Goods and Services.
Total Spending equals Money amount, and the Circulation velocity of the money. What does this mean? This means simply that if an economy had a certain amount, say a hundred dollars, and it spent that 10 times a year, then the total spending for the year would be a thousand dollars.
The Theory of Assumptions
While most of the theory’s beliefs are merely assumptions there are ways to back it up, just like there are ways to contest the theory. The theory assumes that velocity of circulation and the amount of transactions are pretty constant, but in the long term they can fluctuate some. However, it’s been proven and contested at times that the velocity is constant, but this all depends on how much consumers and businesses are spending on impulses which aren’t always a constant number.
QTM has been challenged in the 1930’s as mentioned above by John Maynard Keynes, but even in the 1980’s monetarism was extremely popular, as was the QTM because even economic leaders, and the American Stock Exchange utilized its principles.
Conclusion – Quantity Theory of Money
While it was very common for the quantity theory of money to be in practice throughout even the 1980’s, towards the modern day, it has been pretty much eluded on an economic rule, and therefore the theory is still just a theory and a practice which is ultimately only used by certain individuals who practice strong beliefs of monetarism. However, around 2015, the practice of monetarism has pretty much died down and people have laid the theory itself to rest, and it’s really not practiced as much as it used to be.
The truth of the matter? Inflation is still very much a real thing, and it does seem that while some of the theory’s practices may have been able to be contested, the way that inflation does seem to work is still something that has been proven time and again, and the leading cause? Quite simply put, the increase in supply and demand, as well as the amount of currency devaluation, which leads to higher exports and lower imports. Therefore, this leads to a higher demand which leads to higher prices, meaning somewhere in there, Friedman was right, and so was Keyne. At the same time, both of them were wrong about how things worked in other aspects.