Inflation - Quantity Theory of Money
What Is the Quantity Theory of Money?
The Quantity Theory of Money (QTM) is an economic theory that claims that the total amount of money in circulation affects the overall price level of goods and services. According to the QTM, when the amount of money increases faster than the production of goods or services, then prices will rise. Conversely, if the amount of money decreases relative to the productivity level, prices will decrease. In other words, it suggests a direct relationship between money supply and inflation.
The Fisher Equation
There are two general caveats that people will apply to the QTM:
New money has to actually circulate in the economy to cause inflation.
Inflation is relative—not absolute.
These caveats are derived from an applied simplification of the Fisher Equation: (M)(V)=(P)(T) where:
M=Money Supply
V=Velocity of circulation (the number of times money changes hands)
P=Average Price Level
T=Volume of transactions of goods and services
In other words, prices tend to be higher than they otherwise would have been if more dollar bills are involved in economic transactions.
Monetarism
Monetarism is an economic theory that emphasizes the role of money in the economy. Monetarists believe that changes in the supply of money are the primary drivers of economic growth and stability. They argue that central banks should control inflation by controlling the supply of money, rather than relying on government spending or taxation to do so. Monetarism has been influential in shaping macroeconomic policy since the 1970s, and it remains an important part of modern economic thought.
Keynesianism
Keynesianism is an economic theory developed by British economist John Maynard Keynes in the early 20th century. It emphasizes that government spending can be used to boost a flagging economy and believes in active fiscal policy and the use of budget deficits to stimulate growth. Additionally, Keynesian economists often support interventionist policies such as subsidies, taxes, and price controls to ensure a healthy level of unemployment. The approach has been influential in influencing macroeconomic policy since the Great Depression.
The main tenet of Keynesian economics is that government spending can stimulate the economy and lead to higher economic growth. Keynes believed that when private investment was inadequate, the government could intervene and increase demand through public works programs and other investments. Additionally, Keynesians advocate for increased taxation as a way to redistribute income from wealthy to poorer individuals and households. They also support active fiscal policy initiatives such as budget deficits or changes in taxes or government spending in order to achieve full employment, stabilize prices, and promote economic growth. Overall, Keynesian economics encourages active government intervention in the economy in order to create sustainable economic growth.
Criticisms of Keynesianism
Keynesianism has been criticized for its reliance on government intervention and its disregard for the effects of increased taxes on individuals and businesses. It is also argued that Keynesian policies can lead to an unsustainable rise in the public debt and can create an environment of inflation and higher prices. Additionally, Keynesian policies may discourage long-term economic growth by creating disincentives for businesses to invest in their workforce or their operations. Lastly, some economists have argued that Keynesian economics fails to address structural problems within the economy such as income inequality or the slow rate of productivity growth.
