What are the Dissimilarities between the Cash Balances Equation and the Equation of Exchange?

Though the cash balances equation and the equation of exchange are similar in form, to some extent, their implications are quite different.

1. Differences in the concept of Money Supply:

The cash-balances model is a stock concept, whereas the transactions-velocity model is a flow concept. According to the former, the money supply is a given stock at any point in time; whereas the latter viewed money supply as a flow over a period of time. Thus, in the former V is disregarded, while in the latter V becomes indispensable.

2. Differences in the concept of Demand for Money:

The two versions make use of different concepts of demand for money. While the Fisherian version emphasizes the medium of exchange function of money, the Cambridge version stresses the store of value function.

3. Differences in Approach and Emphasis on V vs. K:

While Fisher stressed the spending aspect of money, the Cambridge economists emphasised the holding aspect of money. Therefore, V is significant for the Fisherians and K is important in the Cambridge approach.

However, K is the most significant factor in the cash-balance approach which causes a genuine break from the Fisherian version of quantity theory.

To quote Prof. A.H. Hansen, in this context: “The Marshallian version of the quantity theory M = KY represents a fundamentally new approach to the problem of money and prices.

It is not true, as is often alleged, that the ‘cash-balance’ equation is merely the quantity theory in the new algebraic dress. Substituting PO (Price level times output) for Y, the Marshallian equation becomes M = KPO.

Arithmetically, K is simply a reciprocal of V in the equation MV = PO. But it does not follow from the mere fact that V = 1/K as an arithmetic identity, that the Marshallian analysis in fact is the same thing as the Hume-Fisher analysis. To assert this is to miss entirely the significance of K in the Marshallian equation.”

Further, as Hansen stated, in cash balance theory a shift of K may start an upward or downward movement thus it is K, not M that holds the stage.

4. Mechanistic Approach vs. Realistic Approach:

In fine, Fisher’s equation is mechanistic, whereas Cambridgeequation is realistic and takes into account the human factor.

Fisher’s equation is mechanistic in the sense that it does not explain how changes in the volume of money bring about alterations in the pries level.