Question

Irving fisher and the quantity theory money

Answer 1

Irving Fisher was an American economist, statistician. He was a pioneer of Monetarism.

According to Fisher, “Other things remaining unchanged, as the quantity of money in circulation increases, the price level also increases in direct proportion and the value of money decreases and vice versa”.

He proposed an equation.

MV=PT

Wherein, Supply of money is MV

M= money in existence

V= velocity of money. ( The number of times money changes hands).

and demand for money = PT.

P = average price level

T= total amount of things.

Supply of money = Demand for Money .

Fisher's theory explains causal relationship between the money supply and the price level.

We can say that following are broad conclusions of this theory.

i. The price level in a country is determined by the supply and the demand for money.

ii. Given the demand for money, changes in supply of money lead to proportional changes in the price level.

Drawback of this theory is that this equation (MV=PT) does not reveal anything about the causal relationship between money and prices. It does not indicate which the cause is and which is the effect.

Assumptions of his theory were:

1. Velocity of money (V) is constant and is not influenced by the changes in the quantity of money hence, change in supply of money (M) will have no effect on the velocity of money (V).

2. There is a proportional relationship between currency money (M) and bank money (M’). (Bank money is a credit creation by the commercial banks)

Criticism: He had assumed that all variables(M,V,P and T) are independent. However, in reality as money supply increases, the prices will increase.