Money and Credit

Lecture 3Modern Theoriesof Money

1. Quantity theory of money. 2. Modern monetarist theories of money. 3. The modern synthesis of theory of money.

Content

Main definitions:o Casualtyo Proportionalityo Homogeneityo Conjuncturalo Monetarismo Rate of interesto Monetary ruleo Cash balanceso …………..

Quantitative theory of money

Abstract theory of money Monetary theory of money

Nominalistic theory of money

State theory of money

Functional theory of money

Marxist theory of money

Classical quantitative

theory of money

Neoclassical quantitative

theory of money

Modern monetarism

Keynesian concept of monetary theory

Neokeynesian concept of monetary

theory

In XVIII-XIX centuries variant of this theory proclaimed that, if all other conditions held constant the level of commodity prices in average varies directly with the quantity of money in circulation. This statement first applies the real money and then spread on paper money.

Thus, the quantity theory involves two basic provisions:• postulate of causality (the price depends on the amount of money);• postulate of proportionality (prices vary directly with the amount of money).

1. Quantity theory of money.

Treatise "The answer to the paradox de Malstrua“

“High prices are caused by many reasons, but the main one is the significant increase in gold and

silver”

Jean Bodin(1530–1596)

David Hume(1711–1776)In the essay "About the Money" (1750) he proposed and proved the principle of "homogeneity postulate" - doubling of the amount of money leads to a doubling of the absolute level of prices expressed in money, but does not affect the relations of exchange ratios of particular products.

John Locke(1632–1704)

Irving Fisher(1867–1947)

He clearly defined the relationship between various key factors of monetary and non-monetary sectors.

He argued that the decisive factor that regulates and determines the value of money (gold and silver) is

their number. This postulate of John Locke was used by the ideologues of

industrial capitalism.

He expressed the transactional version of the quantity theory by the equation of exchange:

MV = PQwhere Μ - the amount of cash in circulation during the

period;V - velocity of money;Ρ - individual price of goods sold during the

period;Q - quantity of goods.

The basis of the formula is an exchange of commodities. To the right is the sum of prices of all commodities involved in operations, to the left - the sum of all immediate payments.

Irving Fisher

The book "Paper money and metal" , 1916He criticized the classic version ofquantitative theory of money, which was described in the works of I. Fisher. He recognized the formula of "equationof exchange" as the right one, but believed that I. Fisher brought nothing new into the quantity theory of money, but only "successfully completed work and gave an accurate and concise expression of the quantity theory in mathematical form"

Mikhail Ivanovich Tugan-Baranovsky

(1865–1919)

Neoclassical quantity theory of moneyThe "Conjunctural" variant of M. I. Tugan-Baranovsky

The price level is affected by not just one, but all of the factors listed in the "equation of exchange"

The influence of money on prices is not single-valued, straightforward, how it is called by supporters of classical quantity theory

the influence of amount of money on prices is made differentially depending on the duration and scope of quantity of money increasing

opened the mechanism of interdependence between the total amount of money in the country, the amount of money that are out of circulation in savings, and the velocity of money

Contributions of M. I. Tugan-Baranovsky to the development of quantitative theory of money:

The essence of market theory of money of M. I. Tugan-Baranovsky is that the general level of prices, and hence the value of money, is connected by him with not the amount of money, but with the general conditions of commodity-money market or general economic conditions of commodity market.

“Conjunctural” theory of money

Cambridge variant of the quantitative theory of money

Alfred Marshall(1842–1924)

Joan Violet Robinson(1903–1983)

John Maynard Keynes(1883–1946)

The scientists focused on the grounds of accumulation of money of individual members of production, and in this regard have tried to answer the following questions:1) why people keep money;2) what factors determine the demand of economic entities for cash balances.An important feature of the "Cambridge version" is that the size of the accumulation of money had not been imposed on economic entities with "iron necessity" from above, but was connected with the motives of their behavior. It is based on two reasons for money accumulation – as a fund of means of exchange and as a reserve for unforeseen needs.

Cambridge variant of the quantitative theory of money

The formula of A. Pigou – the"Cambridge equation":

M = KPA,where Μ - the amount of currency units;

A - the total amount of production

in physical representation per unit

time;Ρ - the price of products;K - part of the AP, that people

wishto keep as money.

Arthur Cecil Pigou(1877–1959)

The concept of I. Fisher

Cambridge version

In equation of I. Fisher cash flow dynamics is considered at macro level

Cambridge economists focus on motives for accumulation of money by specific subjects of market economy

The methodological basis of the equation of exchange - money as a medium of exchange

The money is not only a medium of exchange, but also the store of medium

The emphasis is on objective principles of money

It is taken into account the psychological reaction of entities for the use of cash

The concept of Fisher refers only to money supply (Ms)

The central problem of Cambridge version is the problem of demand for money (Md)

Keynesian interpretation of the quantity theory of moneyJohn Maynard

Keynes(1883–1946)

J. Keynes tried to overcome theclassical system, which has

created a deep gap between real andmonetary processes.The main channel of

communicationbetween these worlds is the

norm ofinterest, which is under the

forces of money market and in turn influences on decisions making about future investments.J. Keynes assigned an important place for analysis of reasons of money accumulation: transaction, caution and speculative. The first two reflect the role of money as a medium of exchange and payment. The third one is connected with the dynamics for financial assets or bonds.

Keynesian interpretation of the quantity theory of money

The total demand for money (MD) consists of two parts: transaction (MDt), which is a function of income and speculative (MDA), which is a function of interest:

ΜD = MDt + MDA = MD (Y) + MD (r),

where Υ - total revenue;r - rate of interest.

Summary. J. Keynes reconstructed the theory of money by introducing the rate of interest. Money has become an important factor in the formation of investment demand. Recipes" of J. Keynes allowed affecting the employment and volumes of production as the most "narrow" places in the economy. But these "recipes" that were based on a policy of "cheap money" included the inflation element, i.e. receipts issued a large number of means of payment, led to the violation of the proportions in the monetary sphere, supported depreciation and stimulated the growth of prices.

Monetarist version of the quantity theory of money

Milton Friedman(1912–2006)Monetarism is a school of economic thought, which focuses on changes in the quantity of money in circulation as a defining function of prices, income and employment

The main element of the monetarist model is money. They provide a guarantee of payment to the owner, creating a liquidity reserve, etc. In contrast to the theory of transactional type, where the need for money is the sum of barter transactions, the theory of M. Friedman is a "portfolio model" or the theory of "preference assets."

The most significant statements of modern monetarism.

1. The free market economy, based on private property, is potentially capable of complete self-regulation, if some external forces do not prevent this.

2. The monetary sphere (by monetarists) is relatively independent, separated from the sphere of the real economy.

3. The monetary sphere should be the central object of state regulation to create favorable conditions for the full accomplishment of the market mechanism of self-regulation.

4. The analysis of money supply dynamics and dynamics of the crisis in the US economy for about 100 years, made by M. Friedman and A. Schwartz, proved that nominal GDP is in closer correlation with the money supply, than with investment and generating rate of interest, which are recognized by Keynesians as crucial factor influencing the economy.

2. Modern monetarist theory of money.

The most significant statements of modern monetarism.

5. As the consistent supporters of the quantity theory the monetarists base their research on the formula of "equation of exchange" by I. Fischer. 6. Similar to the quantity theory, there is a position of monetarists on the velocity of money and its impact on economic processes.7. Monetarists made new formulations: M – D - P that is considered as a change in the quantity of money (M) affects demand (D) and through it to the price (P).8. M. Friedman suggested the "monetary rule" of long-term monetary policy, for which the state should support a moderate, steady increase in the money supply in proportion to the average annual GDP growth rate and expected inflation. According to this, the increase in volume of money in circulation is determined by a formula ("Friedman`s equation“):

ΔM = ΔP + ΔUwhere ΔM - average annual growth rate of amount of money over a longperiod, %

Δ P - average expected inflation rate, %;ΔU - average annual growth rate of nominal GDP, %.

When the economy of the Western world in 70-80 years came to gradual growth with the absence of high inflation, it appears that urgent local problems for Keynesians and Monetarists have not simply disappeared, but transformed into chronic and simultaneous ones.Inflation and unemployment constantly "glow" in a market economy, threatening to undermine its mechanism in one or the other direction, and sometimes both at once. To avoid this risk, market economy in the new environment needs to be "treated complex" – from the possibility of a surge in inflation and unemployment and stagnation.No Keynesian nor Monetarist prescriptions in their purest form for this are not good, which defined the process of interpenetration of ideas of Keynesian-Monetarist synthesis formation as a new stage in the development of monetary theory.

3. The modern synthesis of theory of money.