Question

From 1650 to 1776, the two strands of monetary theory were _______ and ______. A. money stimulates trade / fiscal policy B. trade stimulates saving / the quantity theory of money C. the quantity theory of saving / investment stimulates capital D. money stimulates trade / the quantity theory of money

Answer 1

The Preclassical Monetary Theory(from 1650 to 1776) primarily consisted of two strands of monetary theory which were the quantity theory of money and money stimulates trade.It was John Law,Jacob Vanderlint,and George Berkeley who put up the argument of "money stimulates trade".The argument largely ignored the connection between money and prices emphasizing the effect of money on output and employment.The idea underlying the theory was that, given a volume of trade,there is an appropriate amount of money required to carry out exchange transaction.The element of truth in the money stimulates trade doctrine was that money is an important determinant of aggregate spending ,which inturn determines the level of employment and output.But especially in two critical respects,this theoretical progression does not go far enough;firstly, it ignores the possible effects of money on price level.Secondly,it overlooks the role of expectations in the decision making process.

The other argument was made by John Locke,Richard Cantillon,and David Hume emphasizing on the connection between money and prices.It was Hume who attempted to reconciliate the money-stimulates-trade theory with the quantity theory of money.Sir James Steuart criticized the quantity theory of money by pointing out that prices where not only a function of the quantity of money.The quantity theory distinguishes between two types of money demand:money is demanded for transaction purposes and it serves as a medium of exchange .A change is price level and change in money demand are directly and proportionally related.However the critics argued that in this theory,the money velocity is not stable and in the short run,prices are sticky ,so the direct relationship between money supply and price level does not hold.