Page 112 - DECO402_Macro Economics

Unit-12: Demand of Money: Quantity Theory of Money

Criticism Notes

Keynes and Keynesians after economists like Crowther, Halm etc have done the below mentioned
criticism of Fisher’s equation:
1. A simple truism or Tautological: In the words of Keynes, “The quantity theory is a truism
which holds in all circumstances though without significance." Quantity theory of money is
a simple truth or a truism. It does not tell anything which people do not know beforehand.
This theory tells us that gross monetary expense of buyers is equal to the gross monetary
income of the sellers. In other words, as many goods and services are sold in the market, that
many are purchased. It is one such truth which even an illiterate person also knows. It is not
known through it that because of change in supply of money, what is the actual reaction of
change happening in price level and of these factors, which factor is the cause and which is
the result. It is also not known through it that why there are changes in supply or quantity
of money. It only tells an identity.
2. Unrealistic Assumption: This theory is based on an unrealistic assumption that price level
is only influenced by changes in quantity of money. Other elements of the equation like V.
V′, and Y have been considered to be constant. We can see that these elements are never
constant in actual life and price level also changes through changes happening in them.
3. Variables are not independent: Fisher’s assumption is that M, M′, V, V′ are independent
variables i.e. one has no influence on the other. But we see that in real life, these variables
are not independent of each other. Change in any one variable, like Y, has its influence on
other variables also.
4. Lop Sided: As per critics, as compared to demand for money, this theory lays more emphasis
on supply for money. Fisher, by assuming the demand for money to be constant has ended
the influence of demand in price determination. As per Fisher, only by change happening in
supply of money, change in price level takes place. It means that importance is given only to
the Money’s job of ‘Medium of Exchange’ and the job of ‘Store of value’ has been ignored.
Hence it is a lop-sided theory.
5. Price Level is not a passive factor: The assumption of this theory that price level is a passive
factor is also wrong. Actually, price level is an active factor. Because of changes in price level,
quantity of trade (Y) is influenced because due to increase in prices, profits increase. As a
result, there is an increase in trade (Y) and quantity of money. That is why due to increase
in prices there is increase in quantity of money and on decrease in trade, quantity of money
decreases.
6. Applicable only in case of full employment: Quantity theory of money is applicable only
in case of full employment. But as per Keynes, economies may also be in a situation of
incomplete employment. In such economies, on increase in quantity of money increase takes
place in production and not in prices.
7. It fails to explain trade cycles: As per Crowther, “The quantity theory is at best an imperfect
guide to the cause of trade cycle. "It is not known through this theory that during recession,
why the prices do not increase even on increasing the quantity of money and during inflation
why do prices increase, even without increasing the quantity of money? The actual reason for
this is that during the days of recession, velocity of money decreases and in the situation of
inflation it increases. But this theory presumes the velocity of money to be constant. Actually,
velocity of money keeps changing.
8. Inconsistent: As per Halm, quantity theory of money in inconsistent. In this effort has been
made to know the quantity of money by multiplying quantity of money, which is related to
a point of time or stock or is a static concept, with velocity, which is related to a time period,
or which is a flowing or a dynamic concept. It is technically inconsistent.

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