Editing Quantity theory of money (section)

==Origins and development==

=== Before 1900: Early contributions ===

Economic historian [[Mark Blaug]] has called the quantity theory of money "the oldest surviving theory in economics", its origins originating in the 16th century.<ref name=Dimand>{{cite book|last1=Dimand |first1=Robert W. |chapter=Monetary Economics, History of |title=The New Palgrave Dictionary of Economics |date=2016 |pages=1–13 |doi=10.1057/978-1-349-95121-5_2721-1 |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_2721-1 |publisher=Palgrave Macmillan UK |isbn=978-1-349-95121-5 |language=en}}</ref> [[Nicolaus Copernicus]] noted in 1517 that money usually depreciates in value when it is too abundant,<ref>Nicolaus Copernicus (1517), memorandum on monetary policy.</ref> which is by some historians taken as the first mention of the theory.<ref name="Volckart 1997">{{cite journal|last=Volckart|first=Oliver|title=Early beginnings of the quantity theory of money and their context in Polish and Prussian monetary policies, c. 1520–1550|journal=[[The Economic History Review]]|publisher=[[Wiley-Blackwell]]|volume=50|issue=3|pages=430–49|year=1997|jstor=2599810|issn=0013-0117|doi=10.1111/1468-0289.00063}}</ref><ref>{{Citation| last = Bieda| first = K.| title = Copernicus as an economist| journal = Economic Record| volume = 49| pages = 89–103| year = 1973| doi = 10.1111/j.1475-4932.1973.tb02270.x}}</ref> Robert Dimand in the chapter on the history of monetary economics in ''[[The New Palgrave Dictionary of Economics]]'' identified [[Martín de Azpilcueta]] (1536)<ref>{{cite book|language=en|last1=Decock|first1=Wim|chapter=Martin de Azpilcueta|title=Great Christian Jurists in Spanish History|series=Law and Christianity |editor1=R. Domingo|editor2=J. Martínez-Torrón|location=Cambridge|publisher=Cambridge University Press|date=2018|pages=126–127|isbn=978-1-108-44873-4 |url=https://www.cambridge.org/core/books/abs/great-christian-jurists-in-spanish-history/martin-de-azpilcueta/4149F4F31247E36DDB5DDAB4AF0C13E4|url-access=subscription}}</ref><ref>{{cite book |last=Grice-Hutchinson |first=Marjorie |title=The School of Salamanca; Readings in Spanish Monetary Theory, 1544–1605 |place=Oxford |publisher=Clarendon |year=1952}}</ref> and [[Jean Bodin]] (1568)<ref name="Hamilton">{{cite book|last=Hamilton |first=Earl J. |title=American Treasure and the Price Revolution in Spain, 1501–1650 |place=New York |publisher=Octagon |date=1965 }}</ref> as the originators of a proper theory usable for explaining the observed quadrupling of prices during the phenomenon known as the [[Price revolution]] following the influx of silver from the [[New World]] to Europe.<ref name=Dimand/>

[[John Locke]] studied the [[Velocity of money|velocity of circulation]],<ref name=Dimand/> and David Hume in 1752 used the quantity theory to develop his [[price–specie flow mechanism]] explaining balance of payments adjustments.<ref>{{Citation| last = Wennerlind| first = Carl| title = David Hume's monetary theory revisited| journal = Journal of Political Economy| volume = 113| issue = 1| pages = 233–37| year = 2005| doi=10.1086/426037| s2cid = 154458428}}</ref><ref name=Dimand/> Also [[Henry Thornton (reformer)|Henry Thornton]],<ref>Hetzel, Robert L.: ''Henry Thornton: Seminal Monetary Theorist and Father of the Modern Central Bank'' (n.d.): 1. July–Aug. 1987.</ref> [[John Stuart Mill]]<ref>John Stuart Mill  (1848), ''Principles of Political Economy''.</ref><ref name="Volckart 1997" /> and [[Simon Newcomb]]<ref>Simon Newcomb  (1885), ''Principles of Political Economy''.</ref><ref name=Dimand/> among others contributed to the development of the quantity theory.

During the 19th century, a main rival of the quantity theory was the [[real bills doctrine]], which says that the issue of money does not raise prices, as long as the new money is issued in exchange for assets of sufficient value.<ref>Roy Green (1987),  "real bills doctrine", in ''The New Palgrave: A Dictionary of Economics'', v. 4, pp. 101–02.</ref> According to proponents of the real bills doctrine, money supply responded passively in response to money demand. Consequently, there could be no causal influence from money to prices; conversely, the connection ran in the opposite direction: Money demand was determined by income and prices, which were affected by inflation, caused by various real (i.e., non-monetary) reasons.<ref>{{cite journal |title=The Quantity Theory of Money: Its Historical Evolution and Role in Policy Debates |journal=Economic Review |date=May 1974}}</ref>

=== 1900–1950: Fisher, Wicksell, Marshall and Keynes ===

The eminent economist [[Irving Fisher]], building upon work by Newcomb, developed the theory further in what has been called "The Golden Age of the quantity theory",<ref name=Dimand/> formalizing the [[equation of exchange]] and attempting to measure the [[velocity of money]] independently empirically.<ref>Irving Fisher  (1911), ''The Purchasing Power of Money'',</ref><ref name=Dimand/> Fisher insisted on the long-run [[neutrality of money]], but admitted that money was not neutral during transition periods of up to 10 years.<ref name=Dimand/> Another renowned monetary economist, [[Knut Wicksell]], criticized the quantity theory of money, citing the notion of a "pure credit economy".<ref>{{cite book|url=https://mises.org/books/interestprices.pdf|title=Interest and Prices|first=Knut |last=Wicksell|date=1898}}</ref> Wicksell instead emphasized real shocks as a cause of observed price movements and developed his theory of the [[natural rate of interest]] to explain why the monetary authority should stabilize by setting the interest rate rather than the quantity of money – a position that has received renewed attention during the 21st century, exemplified in the influential [[Taylor rule]] of monetary policy.<ref name=Dimand/>

The extremely influential neoclassical economist [[Alfred Marshall]], Professor at Cambridge, expounded the quantity theory in a version which stated that desired cash balances (i.e., [[money demand]]) was proportional to nominal income. The proposition is normally written  M = kPY, where k is the proportionality factor. This is known as the [[Cambridge equation]], a variant of the quantity theory. As the coefficient k is the reciprocal of V, the income velocity of circulation of money in the equation of exchange, the two versions of the quantity theory are formally equivalent, though the Cambridge variant focuses on money demand as an important element of the theory.<ref name=Dimand/> 

Marshall's disciple [[John Maynard Keynes]] extended his monetary analysis in several ways and eventually integrated it into his ''[[General Theory of Employment, Interest and Money]]'', published in 1936, which formed the cornerstone of the [[Keynesian Revolution]]. Keynes accepted the quantity theory in principle as accurate over the long run, but not over the short run, coining in his 1923 book ''[[A Tract on Monetary Reform]]'' the famous sentence, "''In the long run, we are all dead''".<ref name=Tract/> He emphasized that money demand (or, in his terminology, [[liquidity preference]]) depended on the interest rate as well as nominal income,<ref name=Tract>[http://203.200.22.249:8080/jspui/bitstream/123456789/2209/1/A_tract_on_monetary_reform.pdf Tract on Monetary Reform, London, United Kingdom: Macmillan, 1924] {{webarchive |url=https://web.archive.org/web/20130808215235/http://203.200.22.249:8080/jspui/bitstream/123456789/2209/1/A_tract_on_monetary_reform.pdf |date=August 8, 2013 }}</ref><ref>"Keynes' Theory of Money and His Attack on the Classical Model", L. E. Johnson, R. Ley, & T. Cate (International Advances in Economic Research, November 2001) {{cite web|url=http://216-230-72-154.client.cypresscom.net/journal2/iaer/nov_01/johnson_pdf.pdf |title=Keynes' Theory of Money and His Attack on the Classical Model |access-date=June 17, 2013 |url-status=dead |archive-url=https://web.archive.org/web/20130717074923/http://216-230-72-154.client.cypresscom.net/journal2/iaer/nov_01/johnson_pdf.pdf |archive-date=July 17, 2013 }}</ref> and contended that contrary to contemporaneous thinking, velocity and output were not stable, but highly variable and as such, the quantity of money was of little importance in driving prices.<ref name="0055d26.netsolhost.com">"The Counter-Revolution in Monetary Theory", Milton Friedman (IEA Occasional Paper, no. 33 Institute of Economic Affairs. First published by the Institute of Economic Affairs, London, 1970.) {{cite web |url=http://0055d26.netsolhost.com/friedman/pdfs/other_academia/IEA.1970.pdf |title=The Counter-Revolution in Monetary Theory|access-date=2013-06-17 |url-status=dead |archive-url=https://web.archive.org/web/20140322030331/http://0055d26.netsolhost.com/friedman/pdfs/other_academia/IEA.1970.pdf |archive-date=2014-03-22 }}</ref> Rather, changes in the money supply could have effects on real variables like output.<ref name="minsky_keynes">Minsky, Hyman P. ''John Maynard Keynes'', McGraw-Hill. 2008. p.2.</ref>

At the same time as Keynes personally and his followers which contributed to the resulting theoretical foundation of [[Keynesian economics]] in principle recognized a role for monetary policy in stabilizing economic fluctuations over the [[business cycle]], in practice they believed that [[fiscal policy]] was more efficient for this purpose, maintaining that changes in interest rates had little effect on demand and output. The Keynesian paradigm came to dominate macroeconomic thinking until the 1970s, assigning little attention to monetary policy.<ref name=blanchard>{{cite book |last1=Blanchard |first1=Olivier |title=Macroeconomics |date=2021 |publisher=Pearson |location=Harlow, England |isbn=978-0-134-89789-9 |edition=Eighth, global}}</ref>

=== Monetarism ===

However, from the 1950s and increasingly during the 1960s, the Keynesian view was challenged by an initially small, but increasingly influential minority, the [[monetarist]]s, the intellectual leader of which was [[Milton Friedman]].<ref name=blanchard/> In response to the Keynesian view of the world, he made a restatement of the quantity theory in 1956<ref>Milton Friedman (1956),  "The Quantity Theory of Money: A Restatement" in ''Studies in the Quantity Theory of Money'', edited by M. Friedman. Reprinted in M. Friedman ''The Optimum Quantity of Money'' (2005),  [https://books.google.com/books?id=XVCgcHQS_nQC&dq=%22Studies+in+the+Quantity+Theory+of+Money%22+restatement&pg=PA51 51]-[https://books.google.com/books?id=XVCgcHQS_nQC&dq=%22Studies+in+the+Quantity+Theory+of+Money%22+restatement&pg=PA67 p. 67.]</ref> and used it as a cornerstone for monetarist thinking.<ref name="0055d26.netsolhost.com"/>

Friedman agreed that money could affect output in the short run. Indeed, he believed that monetary policy was much more powerful in this respect than fiscal policy. Together with [[Anna Schwartz]], he wrote in 1963 the influential book ''[[A Monetary History of the United States]]'', concluding that movements in money explained most of the fluctuations in output, and reinterpreted the [[Great Depression]] as the result of a major mistake in American monetary policy, failing to avoid a large contraction in the money supply during the 1930s.<ref name=blanchard/><ref>{{cite encyclopedia|url=http://www.britannica.com/EBchecked/topic/486147/quantity-theory-of-money|title=Quantity theory of money|encyclopedia=[[Encyclopædia Britannica]]|publisher=[[Encyclopædia Britannica, Inc.]]}}</ref> 

At the same time, Friedman was sceptical as to the use of active monetary policy to stabilise output, believing that knowledge of the economy was too little to ensure that such policies would improve rather than worsen the situation. Instead, he advocated a simple monetary policy rule of maintaining a steady growth rate in money supply, which would not result in perfect short-run stabilisation, but in accordance with the quantity theory would ensure a steady long-run inflation rate. This came to be the main policy recommendation of the monetarists.
<ref>Milton Friedman (1958), "The Supply of Money and Changes in Prices and Output", testimony to Congress. In ''Studies in the Quantity Theory of Money'', edited by M. Friedman. Reprinted in M. Friedman ''The Optimum Quantity of Money'' (2005).</ref>

Consequently, the monetarist application of the quantity-theory approach aimed at removing [[monetary policy]] as a source of macroeconomic instability by targeting a constant, low growth rate of the money supply.<ref>Friedman (1987), "quantity theory of money", p. 19.</ref> The [[zenith]] of monetarist influence came during the late 1970s and the 1980s, after inflation had risen in many countries during the 1970s caused by the [[1970s energy crisis]], and the [[fixed exchange rate system]] among major Western economies known as the [[Bretton Woods system]] had been dissolved. In that situation several central banks turned to a money supply target in an attempt to reduce inflation. For instance the U.S. [[Federal Reserve System]] led by chairman [[Paul Volcker]] announced a money growth target, starting from October 1979.<ref name=Fed/> 

The results were not satisfactory, however, because the relationship between monetary aggregates and other macroeconomic variables proved to be rather unstable. Similar results prevailed in other countries.<ref name=Fed>{{cite web |title=Federal Reserve Board – Historical Approaches to Monetary Policy |url=https://www.federalreserve.gov/monetarypolicy/historical-approaches-to-monetary-policy.htm |website=Board of Governors of the Federal Reserve System |access-date=1 October 2023 |language=en |date=8 March 2018}}</ref><ref>{{cite web | first = Ben | last = Bernanke | author-link = Ben Bernanke | title = Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective | publisher = Federal Reserve | year = 2006 | url = http://www.federalreserve.gov/newsevents/speech/bernanke20061110a.htm }}</ref> Firstly, the relation between money growth and inflation turned out to be not very tight, even over 10-year periods, and secondly, the relation between the money supply and the interest rate in the short run turned out to be unreliable, too, making money growth an unreliable instrument to affect demand and output. The reason for both problems was frequent shifts in the demand for money during the period, partly because of changes in [[Financial intermediary|financial intermediation]].<ref name=blanchard/> This made velocity unpredictable and weakened the link between money and prices implied by the quantity theory. Milton Friedman later acknowledged that direct money supply targeting was less successful than he had hoped.<ref>{{cite report |doi=10.2139/ssrn.958933 |title=Milton Friedman and U.S. Monetary History: 1961–2006 |year=2007 |last1=Nelson |first1=Edward |s2cid=154734408 |url=https://files.stlouisfed.org/files/htdocs/publications/review/07/05/Nelson.pdf }}</ref> 

==== New classical economists ====

For a third group of post-war macroeconomists beside Keynesians and monetarists, the [[new classical macroeconomics|new classical economists]], the quantity theory of money was also a doctrine of fundamental importance, but [[Robert E. Lucas]] and other leading new classical economists made serious efforts to specify and refine its theoretical meaning. These theoretical considerations involved serious changes as to the scope of countercyclical economic policy.<ref>{{cite book |last=Galbács |first=Peter |title=The Theory of New Classical Macroeconomics. A Positive Critique |location=Heidelberg/New York/Dordrecht/London |publisher=Springer |year=2015 |isbn= 978-3-319-17578-2 |doi=10.1007/978-3-319-17578-2 |series=Contributions to Economics }}</ref> The new classical model held that even in the short run, monetary policy could not be used to stabilize output as only unexpected changes in money could affect real variables. However, this view did not gain widespread support, failing to be confirmed by empirical tests.<ref>{{cite web |last1=Thoma |first1=Mark |title=Economist's View: New Classical, New Keynesian, and Real Business Cycle Models |url=https://economistsview.typepad.com/economistsview/2012/04/new-classical-new-keynesian-and-real-business-cycle-models.html |access-date=30 September 2023 |date=4 April 2012}}</ref> Empirically, evidence generally supports that there is a short-run linkage between money and economic activity.<ref>R.W. Hafer and David C. Wheelock (2001), [http://research.stlouisfed.org/publications/review/01/0101rh.pdf "The Rise and Fall of a Policy Rule: Monetarism at the St. Louis Fed, 1968–1986"], Federal Reserve Bank of St. Louis, ''Review'', January/February, p. 19.</ref>

=== After 1990: Decline of money supply targeting ===

Following the difficulties of the 1980s in conducting a satisfactory monetary policy by money supply targeting, most central banks, including the U.S. [[Federal Reserve]], turned away from focusing on monetary aggregates, instead implementing their policies by setting short-term interest rates.<ref name="Palgrave">{{cite book |last1=Friedman |first1=Benjamin M. |chapter=Money Supply |chapter-url=https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_875-2 |title=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan UK |pages=1–10 |language=en |doi=10.1057/978-1-349-95121-5_875-2 |date=2017|isbn=978-1-349-95121-5 }}</ref> Among monetary researchers, the demise of the money supply as a policy variable was recognized and rationalized by [[Michael Woodford (economist)|Michael Woodford]].<ref>{{cite journal |last1=Woodford |first1=Michael |title=How Important Is Money in the Conduct of Monetary Policy? |journal=Journal of Money, Credit and Banking |date=2008 |volume=40 |issue=8 |pages=1561–1598 |doi=10.1111/j.1538-4616.2008.00175.x |jstor=25483463 |url=https://www.jstor.org/stable/25483463 |access-date=30 September 2023 |issn=0022-2879|hdl=10419/189380 |hdl-access=free }}</ref>

From 1990, the new principle of [[Inflation targeting|inflation targets]] as the basis for a country's monetary policy gained popularity, starting with New Zealand and eventually spreading to most developed countries. Inflation targeting countries set interest rates to influence economic activity via the [[monetary transmission mechanism]], eventually affecting inflation to fulfill their inflation argets. The communication of inflation targets helps to anchor the public inflation expectations, it makes central banks more accountable for their actions, and it reduces economic uncertainty among the participants in the economy.<ref>{{cite web |url=http://www.imf.org/external/pubs/ft/fandd/basics/target.htm |title=Inflation Targeting: Holding the Line |last=Jahan |first=Sarwat |publisher=International Monetary Funds, Finance & Development |access-date=28 December 2014}}</ref> 

Money supply (M2) for some time remained a [[leading economic indicator]] in the United States, but lost its status as such in the [[Conference Board Leading Economic Index]] in 2012, after it was ascertained that it had performed poorly as a leading indicator since 1989.<ref>{{cite web |title=Real M2 and Its Impact on The Conference Board Leading Economic Index® (LEI) for the United States |url=https://www.conference-board.org/pdf_free/economics/BCI_March_Essay.pdf |website=www.conference-board.org |publisher=The Conference Board |access-date=3 September 2023 |date=March 2010}}</ref> Also in the policy making of the [[European Central Bank]] from 1999, monetary aggregates, which were initially officially assigned a prominent role as one of two pillars upon which the ECB monetary policy rested, were assigned a graduately more peripheral role among the indicators informing the bank's interest rate decisions.<ref>{{cite web |last1=Papadia |first1=Francesco |last2=Cadamuro |first2=Leonardo |title=Does Money Growth Tell Us Anything about Inflation? |url=https://www.bruegel.org/sites/default/files/wp_attachments/WP-2021-11-041121-1.pdf |website=bruegel.org |publisher=[[Bruegel (think tank)|Bruegel]] |access-date=30 September 2023}}</ref>