The Quantity-theory-of-money (QTM) has had been the
holy-grail of economics for more than a century and is said to have a link with
the Albert Einstein’s famous e = mc2...
...because
both have connections with a mass and a velocity of something... The equation of the quantity theory, MV =PT,
also has mass or quantity of money (M) and velocity of circulation of money (V)
which decides the level of inflation (P), and, real prices of goods and
services in the economy (T) or nominal prices (N). Or we can also write it as
MV = N, where the nominal-level of prices equals real-prices multiplied by
inflation, which says mass of money and its velocity decide the level of prices
in the economy... The same quantity-theory of money explains that money-supply
decides the level of inflation and interest-rate in the economy. The interest
rate or price of capital remains the most important price for the economy’s
growth rate. There are many types of interest rate, but economists mostly view
real-interest, nominal interest rate minus inflation, as more significant in deciding
the level of investment and growth. However, ordinary public regard nominal or
market interest rate, vital for spending. But, indeed, there is a difference
between nominal and real interest rate, and if you want the real picture, real
interest rate reflects the real-gain or real-sacrifice for the public. The
majority does not know about it and everybody is not an economist. It is a kind
information-asymmetry between economists and the general-public, but still
important for agent’s actions and the outcomes... Nonetheless, money-supply and
interest-rate has a direct effect on demand and supply to achieve full
employment and higher economic-growth with increase in the value of money and
not just price-stability, because increase in the value of money or deflation
could help increase demand, which in the future might increase inflation and
interest rate to cross the liquidity-trap visible in the developed-world. In
the liquidity-trap interest-rates remains close to zero for a long-period of
time due to low prices. In the developed world, our recent study shows, that
despite so massive increase in the supply-of-money prices have shown a
downward-slide, especially price of capital which should otherwise increase in
case of a valid quantity theory of money. Prices or expectations of changes in
it have a direct effect on the economic-growth. In other words, prices play an
important role in economic-growth, and lower prices are more expansionary because
it increases demand (Tobin). It may also be called law of prices. But, it works
with both demand and supply. When prices fall demand increases and when they
rise supply increases. It is expansionary both ways, but more expansionary downwards.
And, we know well that lower price of capital or interest-rate is also
expansionary in terms of investment and demand-supply, and economic-growth. In
almost all the prior models a higher money-supply and higher savings result in
lower interest rate which is very important for investment and economic
expansion. In the recent version of the
quantity-theory-of-money, prices decrease and not increase when the
monetary-volume increases. The central banks are trying to increase the
money-base and reduce interest rate or price of capital, just reverse of the
Fisher’s equation of exchange (MV = PT) that more money-supply would increase
inflation and interest-rate. Under the new circumstances the
quantity-theory-money and the equation of exchange do not hold the same
conclusions as before. Since, in the new version increase in the quantity of
money is likely to reduce price-level with low level of interest-rate. Increase
in the monetary-base would reduce price or cost of capital and the general
price-level. The long held opinion that increase in money-supply reduces the
value of money (because of inflation) might not be true under the present case,
because more money-supply is likely to reduce interest cost of production,
which also increases supply and more supply may reduce the price-level, the law
of supply. But, when demand is deficient more supply could reduce the
price-level, and, the economy would fall in lower prices and interest rate, and
probably will push economy in the liquidity trap. The central-banks are
increasing money-supply, lowering interest-rate, increasing supply and also
targeting inflation, which might not work because supply-side is improving, but
excess of labour-supply and low wage growth may be responsible for weak-demand.
Inflation-targeting could increase prices or inflation which might hurt
real-wages and demand. The banks might try to reduce unemployment by increasing
money and reducing interest-rate or cost of capital, but when cost is going down
how inflation would pick. Inflation would increase when labour becomes scarce
and demand higher wages to switch to other profitable locations. Higher
money-supply and lower interest-rate also point that capital is not scarce, but
after full-employment labour becomes scarce and might demand more wages which
may also result in higher demand, inflation, interest-rate, and possibly exit
from the liquidity-trap. Nevertheless, the results of the equation of exchange
of the quantity theory of money have changed in the past few decades. Moreover
scientists still use Newton’s method to launch rockets instead of Einstein
which also might change in effects and interpretations...
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