Short Essay on the Evaluation of Quantity Theory of Money

1. It focuses on immediate rather than ultimate factors:

The Quantity Theory equations (both Cambridge and Fisherian) indicate some factors like M, V, T, K, R as direct determinants of the value of money.

But, actually all these variables are affected by a complexity of economic factors like consumption, savings, investment, income, etc. A number of technical, institutional, psychological factors play their part in the macro-economic drama in a modem economy. Hence, to know the real determinants of the price level and the value of money, one has to go beyond the quantity equations.

In short, the quantity theory equations account for only immediate forces affecting the value of money, but furnish little exposition about the ultimate factors behind the scene, which are really the villain of the piece.

2. Exogeniety of Money Supply:

In quantity equations, the quantity of money M is assumed to be an exogenous and policy-determined variable. But modern economists say that M is an endogenous variable and likely to respond to P when P, the price level, changes on account of cost-push elements.

3. Lacks analytical approach:

In the transactions and cash-balances equations, all kinds of goods are lumped together. No analytical distinction is made between consumption goods and capital assets to examine their effect upon income, employment, output and prices.

Again, the quantity theory pays too much attention to the level of prices, as if the changes in prices are the most critical and significant phenomena in the economic system.

Though prices constitute an influential factor in economic operations, it cannot be said that all changes in economic activities are brought about by changes in the price level, but the quantity theory implies that the price fluctuations are the cause of trade cycles.

However, changes in price level are not the cause but effect of some factors in the economy which are left unconsidered in the equations.

4. Validity in long-run order:

Quantity equations are, by and large, equilibrium equations for the money market in the long term. They are true only in the long run and not in the short run.

5. No real guidance to policy market:

The quantity theory of money furnishes no relevant guidance for an appropriate monetary policy to avoid trade cycles, because they lay emphasis only on secular long-run prices, while a trade cycle is relatively a short-term phenomenon.

The theory implies that stability in the value of money can be effectuated through regulation of currency money. But historical evidences do not support this view. In some cases, concentration of money supply has brought about a fall in prices.

But there are many cases where even a substantial expansion in the supply of money has failed to bring about a rise in prices during a depression. This is because, it is difficult to induce people to spend more, while they can be easily prevented from spending more.

It is like the saying that you can take the horse to the river but you cannot make him drink water if it does not want to. This shows that the quantity of money and prices have no immediate financial relationship.

6. Manipulative Approach:

The quantity theory equations trace the result but without explaining the process involved in obtaining it. Equations pose a direct relationship between the changes in the money supply and the price level. But, actually there is no direct and proportionate relationship as depicted.

In short, the quantity theory lacks a chained analysis of causation. It traces the effects of changes in the money supply on the price level. But, actually there is no direct and proportionate relationship as depicted.

7. Consequence rather than causation:

The quantity of money is not a causative factor in the state of business and a determinant of value, but it is only a consequence. In fact, the value of money is a consequence of income rather than the quantity of money.

For, if people have money income, they would spend it partly or fully. This would increase the velocity of circulation and monetary demand for goods and services and consequently prices would rise if the supply of goods and services is scarce.