Quantitative Theories of Money (Fisher & Cambridge)

1) What is the Quantity Theory of Money (QTM)?

The Quantity Theory of Money explains the relationship between:

• money supply,
• price level,
• and output.

In its classical form, it suggests that, other things equal, changes in money supply lead to proportional changes in prices.

2) Fisher’s Transaction Approach (Equation of Exchange)

2.1 Fisher equation

where:

• $M$ = money supply
• $V$ = velocity of circulation (times a unit of money is used in transactions)
• $P$ = average price level
• $T$ = volume of transactions

Often replaced by income version:

where $Y$ is real income/output.

2.2 Key assumptions (classical)

• $V$ is stable (constant).
• $Y$ is given at full employment (in the short run of classical model). Then:

So money is neutral in real terms (affects prices, not real output).

3) Cambridge Cash-Balance Approach

Cambridge economists focused on money as a store of value and desired cash holdings.

3.1 Cambridge equation

where:

• $k$ is the fraction of nominal income people wish to hold as money.