Explain Critically fisher’s Quantity Theory of Money
Critically fisher’s Quantity Theory of Money
Introduction
The quantity theory of money was first introduced by Davan Zat in the 16th century. After it David Hume and J.S Mill had worked on this Theory in 17th and 18th centuries. But the Theory is most famous in 19th centuries by Irving Fisher, American economist in his book “The Purchasing Power of Money” in 1911 with the help of Equation.
In his book he presented the money as value of money that means The Purchasing power of money. And it shows the inverse relationship between value of money and price level. Now we discuss in detail about the Quantity Theory of Money.
Definitions
By Irving Fisher
“Other things remaining unchanged as the quantity of money in circulation increases, the price level also increases in direct proportion and the value of money decreases and vice versa.”
By Prof. Taussing
“Other things remaining the same, double the quantity of money, price level will be twice high as before; and the value of money on half. Half the quantity of mo ey, prices will be one half of what they were before; and the va ue f money doubles.”
Assumptions of Theory
Full Employment
The theory is based on the assumption of full employment in the country.
Price as a passive factor
It assumes that price is a passive factor. It means that if means that it is affected by other factors in the equation but does not affect others.
Constant velocity of money
According to fisher equation the velocity of circulation of money and bank money is constant.
No change in volume of trade
The total volumes of transaction (goods and services produced) remain same and are not affected by change in money supply.
Barter Transactions
Quantity theory of money is applicable on the money economy. It is not applicable on barter system.
Proportional relation between M&M1
There is proportional relation between currency money (M) and bank money (M1).
No change in hoarded money
There should be no change in hoarded money. Suppose it increases, the money in circulation will decrease, prices will fall and the value of money will rise.
Criticism
Circulation of money
It is very difficult to measure the circulation of the legal money and credit money, therefore velocity of money can not be measured in a country.
Ignore demand for money
The theory discusses only of money as the main determinant of price level and the value f money. It ignores the role of demand for money in determining price level. Therefore it may be called one sided theory.
Assumption of fully employment
In this theory assumed about the full employment in the country, it is not possible for any country to provided full employment.
Proportional change
When the price level of goods is changed then on the other hand the quantity of money not changed at the same proportion. Like if quantity of money increase by 10% meanwhile it is not compulsory the price level is also increased by 10%, may be it can decreased.
Static theory
The economist says that it is static theory because in every economy up and downs and changed must occurred. But in this theory does not mention about the changing.
Useless Assumptions
All the equation and diagram are made on the base of some assumptions without them theory is useless, as well as such assumption also useless
Ignores short Run
Lord Keynes says that it ignores the changes in prices in short run period and it considered only long run period.
Trade cycle
As in early ages business faced the situation of depression, like in 1930. Then that time many countries tired to raise general price level by increasing the supply of money. But it was not successes able in that time. So it proved that this theory does not take into account the phases of trade cycle.
Conclusion
The quantity theory of money is not entirely useless. The supply of money does affect the price level. Acknowledging the importance of this theory, miltion Friedman presented wealth theory of demand for money on its basis.
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