Some thoughts on the Quantity Theory of Money

December 15, 2007


John Maynard Keynes once famously wrote that his General Theory was a long struggle of escape from the grips of classical theory and in particular the quantity theory of money.
Nevertheless, there are sometimes some intriguing insights one can glean from the quantity theory particularly when handled in a Keynesian fashion. One such treatment exists in the work of Robert Aaron Gordon in his classic 1961 work on Busines Fluctuations   a work incidentally dedicated to the memory of Joseph Schumpeter and Wesley C. Mitchell.
Gordon in his discussion of the circular flow of income and economic activity posits the following relationship MV(f) +MV(d) + MV(y) = PT(f) + PT(d) + PT(y) =PT where d,f and y   refers to the three types of spending:d- on duplicative transactions where goods are bought and sold more than once as they move through successive manufacturing stages and eventually through wholesalers and retailers to the final customer; f- financial and speculative transactions in securities,land, old buildings, loans of mortgages, etc; y-expenditures on newly produced goods at their point of final use or alternatively to the sum of incomes resulting the sale of these goods.

P of course stands for prices, T for transactions, M for the money stock and V for the velocity of money. The point of these distinctions is to show that not all transactions add to the GDP or produce useful jobs or any jobs at all.

The f sector is particularly interesting in this respect particularly as the financial derivatives market has grown globally to several trillion dollars. Money which circulates in this sector of the economy may not produce new jobs except among those financial agents who sell the assets involved. Futures markets and options really are closer to casino activities as opposed to real investments.

Indeed , the financial transactions from time to time might even involve the destruction of wealth and threaten the entire income circular flow with instability and job loss. This is not true of the other two sectors. In fact the f sector unlike the other two sectors can have a net negative effect upon the circulation of income and such negative results help explain how recessions interfere with the economic reproduction of the system at the same or higher levels of income.

It also explains how deflationary forces can be unleashed in the economy and the need for compensating monetary and fiscal policy.It should be noted that the impact of the accelerator   in a reverse direction and the pace of technological investment generates its own business cycle sometimes in a downword direction and these originate solely in the y and d sectors as opposed to the f sector.

We can experiment with rewriting the equation in the following way to capture the negative impact of failed speculation in the f sector.

It might be written

(MV(f +) - MV (f-)) +MV(y) +MV(d)= PT(f+-f-)+PT (y)+PT(d).

The negative sign indicates destruction of value and shrinkage of the monetary base due to financial failures that are at least initially not bailed out by the central bank's countercyclical expansion of the banking system.

A further area that needs to be explored is the existence of quasi-hording in the futures markets in currency trading and other financial futures where the time lag between the transaction and the ultimate investment in the real economy is extended.This has some of the characteristics of classic hoarding of cash.

Way back in the mid 1940s Abba Lerner pointed out that in the Keynesian schema net hoarding of cash was impossible because what one person hoarded would be compensated for by another person saving less.In other words it is impossible for there to be societal hoarding so long as the banking system does not increase the supply of money in the Marshallian short period.In other words the store of total money is fixed and subtractions from it must be compensated by additions to it.Lerner writes `There cannot therefore be any net hoarding(or dishoarding) by all the members of society taken together, so that there cannot for the society be any excess of saving over investment(or of investment over saving). S=I.   (See his essay on the General Theory in Seymour Harris's excellent collection The New Economics:Keynes' Influence on Theory and Public Policy, NY Knopf, 1948 `p. 123, which Lerner claims Keynes had read in draft form and had approved as an accurate interpretation of his work)

However, this adjustment process appears instantaneous in the short period. Once we leave the unrealistic realm of the short period and draw some of Robertson's insights about temporality and its impact upon the savings and investment process other conclusions may become possible.