The Quantity Theory of Money:

History and Significance in Economic Thought

Stephen Salvato

Economics 446
Professor Haulman
December 4, 2009

Salvato 2
Since the beginning of human history, man has lived amidst a world of finite resources.
While this difficult, but fundamental truth of economics remains ubiquitous, man has developed
methods to overcome such hardships. Of these methods, trade represents the most essential and
important one. Indeed, traces of trading arise throughout all of history. However, as systems of
trade developed, groups realized the inefficiencies of common bartering. The necessity of
finding another person willing to trade his or her good for the good one possessed currently (a
double-coincidence of wants) required a plethora of time and energy. Upon this realization, in a
monumental step forward in mankinds progress, the earliest forms of money emerged. It is only
right that economists take a keen interest in such an integral part of our society. While
economists ideas and beliefs about money have changed over the ages, the quantity theory of
money has been visited time after time in an attempt to understand clearly the role of money in
an economy.
The quantity theory of money states simply that the money supply has a direct, positive
relationship with the prices of goods and services. As economic thought developed, different
interpretations of this theory led to different ideas of how an economy works, specifically what
role money has in the economy (if any role at all). By this account, the quantity theory of money
has important implications for monetary policy as a tool for directing a countrys economy. By
tracing the theory from Mercantilist thought through Milton Friedman and the Monetarist school
of economics, one can understand how it affected the development of economic thought.
First, this paper will look at the roots of the quantity theory of money in pre-classical
thought. To mercantilists and other pre-classical economists, the quantity theory of money
helped explain how money was linked (or not linked) to the real economy. Following this initial
look, this paper will turn to an analysis of the quantity theory of money and monetary policy in

Salvato 3
classical economics. Using the quantity theory of money, the predominant view during the
classical school of thought was that money remained neutral. However, some economists began
to see situations when prices would not respond in full to changes in money supply. The paper
will then observe neoclassical views of the quantity theory of money (particularly in regards to
Irving Fishers equation of exchange) before moving onto Keynes critique of it. Finally, this
paper will look at Friedmans view of the quantity theory of money and the role that money
plays in the monetarist school of thought.
Early economics had little cohesion as a field of study. Prior to the physiocrats and the
publishing of Adam Smiths seminal work, An Inquiry into the Nature and Causes of the Wealth
of Nations, mercantilism was the persisting school of economics. While it would be fallacious to
claim that mercantilism was a school of thought with a uniform set of economic beliefs, scholars
ideas were not entirely disparate. Mercantilists, whether strict bullionists or proponents of
favorable balances of trade, studied the importance and role of money in an economy. In their
studies lay the roots of the quantity theory of money.
To Mercantilists, the quantity theory of money helped explain how money was linked to
the real economy. Writers like John Law, William Petty, George Berkeley, and Jacob Vanderlint
believed that money stimulated economic activitythe more money in circulation, the greater
the aggregate output.1 Indeed, this idea served as a basis for general mercantilist support of
bullionism and policies to promote a favorable balance of trade. Of the mercantilists, John
Locke, Richard Cantillon, and David Hume stand out as the forerunners to classical economists

Robert B. Ekelund and Robert F. Hebert, A History of Economic Theory and Method (New York: McGraw-Hill
Inc., 2008), pp. 390.

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and represent the highest level of expression of the quantity theory of money in pre-classical
thought.2
John Locke made important inquiries into how money might affect output. As part of his
investigations, Locke developed a monetary theory of interest.3 In Lockes handling of the
quantity theory of money, changes in the interest rate as result of changes in monetary circulation
affected the economy. By increasing the money supply, more money would be available to
borrow. This scenario promoted borrowing by business, which in turn induced economic
activity. Other mercantilist thinkers, such as John Petty and John Law, also observed that
interest rates tended to vary inversely with the quantity of money.4 While this theory seems
simple and lucid, many economists did not accept Lockes idea. At this time, scholars perceived
the interest rate to be the outcome of the interplay of thrift and productivity rather than of
monetary origins.5 Therefore, Lockes formulation of the quantity theory of money, while
important for seeing interest rates as monetary phenomenon with demonstrative effects on output,
did not become standard thinking in economics until much later.
Using the quantity theory of money, Richard Cantillon made his own contributions to the
understanding of the relationship of money and the economy. A basic view of the quantity
theory of money would have one believe that an increase in the circulation of money would lead
to proportionate increases in the price level.6 However, Cantillon argued that the rise in price
would not necessarily be proportional. Instead, the extent and form of increased spending
determined how much prices would increase.7 If some of the recently introduced money was

Ekelund and Hebert, A History of Economic Theory and Method, pp. 390.
Ibid., pp. 391.
4
Mark Blaug, Economic Theory in Retrospect, 4th ed. (New York: Cambridge University Press, 1985), pp. 22.
5
Ekelund and Hebert, A History of Economic Theory and Method, pp. 391.
6
Ibid.
7
Ibid.
3

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saved, the amount of money available to loan would increase. This would drive down interest
rates, encourage investment, and, eventually, increase output. Therefore, the increase in prices
would not be proportional to the increase in money.8 According to Cantillon, the extent of the
increase in prices was also ambiguous because an increase in money (and therefore consumption
and prices) might also increase moneys velocity.9 The inclusion of velocity was an important
step in monetary theory analysis and Cantillon was the first to introduce concept.10 Cantillons
explanations as to why prices might not rise in proportion to a rise in money supply (increased
saving or increased velocity) are important contributions to understanding how monetary factors
could interact with real [factors] in the economy.11 By using the quantity theory of money and
expanding beyond its basic form, Cantillon gave new insight into the relationship between
money and prices.
David Hume did not accept Cantillons idea of the connection between monetary and real
factors, but his exploration of the relationship between money and price remained the
predominant view of economics for years to come. For Hume, the quantity theory of money was
a long-run explanation of how changes in money lead to proportionate changes in prices with
no corresponding change in the interest rate.12 In other words, Hume believed that if one
doubled the money supply, the price level would also double, while the interest rate remained
unchanged. In this way, money was neutral or merely a veil, an idea that permeated
classical economics.13 That this important classical idea spawned from the quantity theory of

Ekelund and Hebert, A History of Economic Theory and Method, pp. 391.
Ibid.
10
While Petty and Locke had discussed factors similar to velocity, Cantillon was the first to explicitly describe and
use it. Jurg Niehans, A History of Economic Theory (Baltimore, MD: The Johns Hopkins University Press, 1990),
pp. 31.
11
Ekelund and Hebert, A History of Economic Theory and Method, pp. 391.
12
Ibid., pp. 392.
13
Ibid.
9

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money demonstrates how this theory played a vital role in the development of mercantilist and
classical thought.
An additional, final insight of Hume in regards to monetary factors and the real economy
was the specie-flow mechanism. This important mechanism started with Humes idea that rises
in money supply triggered increases in prices (i.e. Humes interpretation of the quantity theory of
money). Next, the increased prices reduced the demand for domestic goods and increased the
demand for foreign goods. The subsequent outflow of gold to meet net foreign debt lowered
the price of goods domestically and raised the price of foreign goods.14 With this mechanism,
Hume dealt an analytical death blow to mercantilism.15 Indeed, Smith incorporated Humes
ideas of neutral money, avoiding heavy analysis of monetary policy in his own work since
money was perceived as nothing more than a medium of exchange.
Through each of these mercantilist thinkers, one can see how the quantity theory of
money was interpreted to come to conclusions of the relationship of money in the economy.
While not all of the ideas resonated with classical economists, several of them, including Humes
idea of neutral money, were to serve as important elements of classical economics. A final
development by mercantilists regarding the quantity theory of money is the equation of exchange
(i.e. the equation that expresses the quantity theory of money, MV = PT). While John Stuart
Mill stated the equation in his Principles of Political Economy, his ideas were based on
mercantilist ideas such as those espoused by Hume. In addition, even before Hume, Brisco had
already written out an equation of exchange, though omitting velocity.16 This equation, an
expression of the quantity theory of money, would continue to influence economic thought.

14

Samuel Hollander, Classical Economics (1987), pp. 24.

Ekelund and Hebert, A History of Economic Theory and Method, pp. 390.
16
Thomas Mayer, David Hume and Monetarism, in The History of Economic Thought, edited by Mark Blaug, pp.
372-384 (Great Britain: Edward Elgar Publishing Co., 1990), pp. 373.
15

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As mentioned earlier, classical economics used many of the ideas developed by preclassical thinkers in discussing moneys relationship in an economy. These ideas were rooted in
the quantity theory of money described by Hume. During the period of classical economics,
Henry Thornton, David Ricardo, and John Stuart Mill expanded on ideas in regards to the
monetary policy and the quantity theory of money that played important roles in the development
of economists view on the impact of money in the economy.
Henry Thornton developed a general-equilibrium approach to monetary theory.17 He
pointed out that if the bank interest rate on loans was below the rate of return on invested
capital, then competition for loans would drive the bank rate up.18 For this reason, only a
change in investment and savings, as determined by the real forces of thrift and productivity,
would change the natural rate of interest.19 Thornton continued to discuss what would happen
if the money supply increased. Similar to what we have seen previously, the increase money
caused an increase in loanable funds, which drove the interest rate down. However, at this point,
investment and savings would be unaltered since there would be no change to thrift or
productivity. Therefore, a gap would be created between the natural rate and the loan rate,
leading to a high demand for loans that could only be satiated by the loan rate rising to its
former level.20 During this movement to the original level, prices would increase. Through his
detailed analysis, Thornton vindicated the quantity theory of money: an increase in money
leads to higher prices but no (long run) change in the interest rate.21
Thornton did not stop in his analysis of monetary policy. In contrast to Humes strict
interpretation of the quantity theory of money, Thornton saw that money might not be neutral. If
17

Niehans, A History of Economic Theory, pp. 106.

Ekelund and Hebert, A History of Economic Theory and Method, pp. 393.
19
Ibid.
20
Ibid.
21
Ibid., pp. 394.
18

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money increased, capital might increase as savings increased. If this increase in capital were the
case, output effects would accompany the higher prices.22 Indeed, Thorntons view that
money could have real effects on the economy led him to believe that discrepancies between the
market price for gold and its mint price were not due to monetary policy (as Smith would
argue), but were due to real causes.23 In addition, under conditions of general unemployment,
an increase in money might lead to increase in output and employment.24 Therefore, Thorntons
conclusions about the quantity theory of money were that money was neutral only in the long run
and then only under certain circumstances.25
David Ricardo, building on Smith to set up the main framework of classical economics,
had few additions to the quantity theory of money. However, one interesting problem relating to
the classical view of economics is how to view downturns in the economy (i.e. a glut). Ricardo
conceded that from a neutral-money interpretation of the quantity theory of money, gluts should
not occur. However, that they do occur did not bother Ricardo too much. Indeed, Ricardo said
that the glut was an unnatural state of society so that while gluts may exist in the short run,
money is neutral in the long run.26 In this way, Ricardos long run view of the economy was
based on a strict interpretation of the quantity theory of money and a belief in Says Identity (that
money is not linked to the real economy and only influences the overall price level).27 Although
other economists had written on the subject, Ricardo abstained from further investigation into the
relationship money had with output.

22

Ekelund and Hebert, A History of Economic Theory and Method, pp. 394.
Niehans, A History of Economic Theory, pp. 107.
24
Ekelund and Hebert, A History of Economic Theory and Method, pp. 394.
25
Ibid.
26
David Ricardo, Principles of Political Economy and Taxation (Amherst, NY: Prometheus Books, 1996), pp. 185.
27
Gary Becker and William Baumol, The Classical Monetary Theory: The Outcome of the Discussion,
Economica (1952), pp. 356.
23

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John Stuart Mill held views on the quantity theory of money similar to Ricardo and other
classical economists, but he also had a few ideas of his own. Mill saw that the quantity theory
was based on the assumption of an equiproportionate distribution of new money relative to
initial money holdings.28 If this assumption broke down (as it did in Cantillons analysis), then
increasing the money supply would not yield a proportional increase in prices. Thus, under
certain conditions, money was not strictly neutral. Two examples of times when money would
not remain neutral include when money was hoarded or when the increase in money kept pace
with a rising T [T is from the equation of exchange and is an index of the real value of
aggregate transitions].29 Finally, Mill believed that the quantity theory of money applied only
to metallic money.30 Mills analysis represents a typical classical economic view of the role of
money in the economy in terms of the quantity theory of money. However, as classical
economic thought was replaced by the neoclassical school of economics, a new look at the
quantity theory of money rose.
Neoclassical economics made little progress in respect to monetary theory, though some
contributions by Irving Fisher, Knut Wicksell, and Alfred Marshall helped modify economists
understanding of the quantity theory of money. This modified understanding was based around
neoclassical economists emphasizing short-run problems in the quantity theory of money.31
Neoclassical economists went away from the strict, Ricardian view of the theory.
Fisher, following Mills idea, wrote a mathematical equation to express the conclusion of
the quantity theory of money.32 The first form of this equation of exchange was MV + MV=

28

Ekelund and Hebert, A History of Economic Theory and Method, pp. 394.
Blaug, Economic Theory in Retrospect, pp. 198.
30
Ekelund and Hebert, A History of Economic Theory and Method, pp. 394.
31
Blaug, Economic Theory in Retrospect, pp. 634.
32
Fisher referred to Simon Newcomb as another economist who had constructed a similar equation earlier. Niehans,
A History of Economic Theory, pp. 277.
29

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PT.33 Simply written, the equation can be expressed as MV = PT, where M is the money supply,
V is the velocity of money, P is the overall price level, and T is the index of the physical
volume of transactions.34 Using this equation, one can observe how money and prices should
be proportional. Since V and T were determined by real factors, a change in money supply
would not affect V or T, ensuring that they remain constant.35 Therefore, this equation justified
the classical view that money and price were proportional in the long run. However, in the short
run, Fisher saw that rates of interest were related to price levels, allowing T to influence V and
M.36 In this way, Fisher began emphasizing how the strict interpretation of the quantity theory
of money broke down in the short run.
Had Fisher stopped with the equation of exchange, he would have done little more than
express the mathematical form of what Mill had written. However, Fisher went further and
discovered the connection between changes in money supply and changes in pricesthe realbalance effect.37 This effect stated that if an individual gains more money, they will have
excess money and seek to reduce their excess money balances by buying more.38 If output did
not change, prices would rise in equal proportion to the increase in money supply. At this point,
a new equilibrium existed. One major issue with Fishers analysis is that he did not see how the
increase in money could trigger increased output by lowering interest rates. Had he done so, he
would have discovered a crucial link to the money market, bond market, and product market.39
Alfred Marshall represents another neoclassical economist who dealt with the quantity
theory of money. For Marshall, a desire to combine monetary and value theories led him to
33

Ekelund and Hebert, A History of Economic Theory and Method, pp. 395.
Ibid.
35
Ibid., pp. 396.
36
Blaug, Economic Theory in Retrospect, pp. 635.
37
Ekelund and Hebert, A History of Economic Theory and Method, pp. 396.
38
Ibid.
39
Ibid., pp. 397.
34

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create an expression for money demand in the formation of the Cambridge equation, M = kPY.40
This equation was the first to focus on the demand for money as well as its supply.41 In this
equation, a formulation of the quantity theory of money, M is the money supply, Y is the real
national income, k is the amount of money that the public may wish to hold in the form of
cash, and P is the price level.42 Unfortunately, Marshall and his followers never realized that k
depended on the interest rates, a shortcoming left over from classical ideas of the quantity theory
of money.43 Still, that the Cambridge equation focused on money demand was an important step
in economic thought. This idea, engendered from the quantity theory of money, would lead to
further monetary theory development later with Keynes.44
It should be pointed out that the Cambridge equation did not differ too much from
Fishers equation of exchange. While Fisher wrote in terms of velocity (V), the Marshallians
used the cash ratio k, which was nothing more than the inverse of V.45 Essentially, Fisher wrote
in terms of transactions, whereas Marshall wrote in terms of income.46 The major reason for
the difference was that each economist used his respective equation for a different purpose.
Fisher used it as a basis for his theory on price level while Marshalls disciples were using the
Cambridge equation to assert the demand for money.47
Another part of the difference between the two equations comes from the different
assumptions made by each of the economists. Fisher, who remained heavily influenced by the
classical tradition of the quantity theory of money, assumed that velocity and the volume of trade

40

Blaug, Economic Theory in Retrospect, pp. 636.

Ekelund and Hebert, A History of Economic Theory and Method, pp. 400.
42
Blaug, Economic Theory in Retrospect, pp. 636.
43
Ibid.
44
Ekelund and Hebert, A History of Economic Theory and Method, pp. 400.
45
Niehans, A History of Economic Theory, pp. 277.
46
Ibid.
47
Ibid.
41

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(T) were independent of the money supply and that the price level was a passive variable.48
Also in line with classical thinking, Fisher assumed the interest rate was based on factors of thrift
and productivity.49 In this way, Fishers assumptions led him to detailing the equation of
exchange in terms of velocity. On the other hand, Marshall assumed that the value of money
was a function of its supply and demand, as measured by the average stock of command over
commodities which each person cares to keep in ready form.50 In keeping with Marshallian
analysis, economists of the Cambridge school used the Cambridge equation to analyze part of the
money market (the demand for money). This would allow them to construct models for that
would allow for partial equilibrium analysis of the money market. From there, Cambridge
economists could see how the money market was related to other markets.
Knut Wicksells major contribution regarding the quantity theory of money came from
his extension of the Walrasian framework to monetary theory.51 Wicksells revised
understanding of the quantity theory of money relied on his statement that prices were
determined by income and that interest rates played an important role in monetary theory.52
Wicksell described how when the money supply fell, cash balances were too small, causing
consumers to reduce their demand for goods and services, leading to a fall in all prices.53 This
explanation helped describe how equilibrium occurred when changes occurred in the money
supply. Wicksell also used ideas of natural and actual rates of interest (a la Thornton) in
analyzing dynamic economic markets.54 Wicksell argued that there was only one market rate of
interest, the normal rate, r, that kept prices stable and he saw this rate as tightly related to the
48

Ekelund and Hebert, A History of Economic Theory and Method, pp. 396.
Ibid., pp. 397.
50
Ibid., pp. 400.
51
Ibid.
52
Ibid.
53
Ibid., pp. 398.
54
Ibid., pp. 399.
49

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real return on capital goods.55 Wicksell did not stray far from the classical view of the quantity
theory of money, but his elaboration on the process of adjustment and the role of interest rates
and aggregate demand in explaining aggregate adjustments to changes in money made his
work invaluable.56
Neoclassical economists, therefore, helped move economists view of monetary policy in
terms of the quantity theory of money away from the strict, proportional view espoused by
classical economists. While gaps still existed, it would not be long before a new line of thinking
would emerge. One economist from this period who rejected many of the common views
regarding the quantity theory of money and its ramifications for monetary policy was Ludwig
von Mises. Mises saw that the equation of exchange did little to explain the ups and downs of
the economy.57 While Mises agreed with Fishers idea that rises in prices were caused by
increases in money supply, he believed Fisher and other adherents to the neoclassical view of the
equation of exchange focused too heavily on the overall price level, P.58 Since P could not be a
good indicator of business vacillations, Mises argued that economists should concentrate on the
money supply, M.59 Mises most important claim was that money was nonneutral and
monetary inflation [was] inherently unstable.60 Money affected not only price, but also
velocity, and the goods and services. Finally, Mises rejected Fishers assumption that V and Q
were constant, causing P to move proportionally with M.61 Mises ideas, especially his focus on
M instead of P, would come back in later economic thought.

55

Niehans, A History of Economic Theory, pp. 255.

Ekelund and Hebert, A History of Economic Theory and Method, pp. 400.
57
Mark Skousen, The Making of Modern Economics: The Lives and Ideas of the Great Thinkers, 2nd ed. (Armonk,
NY: M.E. Sharpe, Inc., 2009), pp. 289.
58
Ibid., pp. 311.
59
Ibid., pp. 312.
60
Ibid., pp. 290.
61
Ibid., pp. 312.
56

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With the advent of the Great Depression, economists understanding of the economy
underwent severe review. At this point, John Maynard Keynes offered a new, revised, and
revolutionary view of economics. In many ways, Keynes rejected the quantity theory tradition
that many earlier economists had accepted.62 Keynes analysis took into account economies
operating under full employment and saw that changes in spending were more likely to affect
output and employmentthan prices.63 He turned the quantity theory of money around,
treating prices as fixed and output as flexible.64 Like Mises, Keynes rejected the notion that
the velocity of money was stable, arguing that a rise in M could be offset by a fall in V, leaving
total spending unchanged.65 Finally, Keynes revised the mechanisms of the quantity theory by
introducing a non-monetary adjustment mechanism, the multiplier.66 As a result, in Keynes
view of economics, the role of money and monetary policy, diminished in importance as fiscal
policy increased.
A huge facet of Keynes analysis involved the interest rates and markets for bonds.
Keynes realized what many economists had overlooked; in addition to holding money for
transactions, people hold it to speculate in the bond market.67 This occurrence could lead to a
liquidity trap, whereby the interest rate was low enough that people believed all bonds were a
bad investment.68 Therefore, the demand for money was based, in part, on speculation. If
money was not predictable, the classical and neoclassical view of the quantity theory of money
would no longer be adequate. In all these ways, Keynesian economics marked a dramatic shift
away from the traditional view of the quantity theory of money.
62

Blaug, Economic Theory in Retrospect, pp. 644.

Ibid.
64
Ibid.
65
Ibid.
66
Ibid.
67
Ekelund and Hebert, A History of Economic Theory and Method, pp. 425.
68
Ibid., pp. 426.
63

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The quantity theory of money had undergone a dramatic revision and for the next few
decades, the Keynesian school of thought replaced the old notions of the quantity theory of
money with a theory of liquidity preference. However, within several decades, critiques of
Keynesian economic ideas brought Milton Friedman to revisit the quantity theory of money. In
Friedmans restatement of the quantity theory of money, he sought to integrate monetary theory
and capital theory for the first time.69 As Mises had done before him, Friedman concentrated on
money supply and the demand for money rather than on prices. Friedmans new look at the
quantity theory of money presented the demand for money as a function of the price level,
permanent income, the ratio of nonhuman to human wealth, and a taste variable.70 In a manner
similar to classical interpretations of the quantity theory of money, Friedman demonstrated that
the demand for real money balances depended only on real variables.71 In all these ways,
Friedman simultaneously revised and restated traditional notions of the quantity theory of money.
The implications of Friedmans interpretation required a rejection of Keynesian ideas for
appropriate economic policies. He argued that instead of analyzing income as Keynes had done,
income should be treated as a discounted, present-value stream of payments, derived from an
existing stock of wealth.72 In short, Friedmans measure of permanent income was a measure
of the yield on capital73 Friedman also argued that Keynes neglect of wealth prevented
Keynesian theorists from accurate, long run analysis. Friedman believed that all types of wealth
were potential substitutes for cash holding.74 In contrast to Keynesian ideas that monetary
policy was relatively ineffective in stimulating the economy, Friedman argued that changes in

69

Ekelund and Hebert, A History of Economic Theory and Method, pp. 478.
Ibid., pp. 479.
71
Ibid.
72
Ibid.
73
Ibid., pp. 478.
74
Blaug, Economic Theory in Retrospect, pp. 645.
70

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the money supply would have large spillover effects into markets since money was a substitute
for goods and services.75 Like traditional views of the quantity theory of money, Friedman
believed that the velocity of money was stable over the long run, meaning that money was an
extremely important determinant of economic activity.76 In fact, evidence from his research
suggested that changes in the money supply were the most important factor affecting the price
level and employment.77
Friedmans emphasis on money in the quantity theory of money led monetarists to
believe inflation as a purely monetary phenomenon.78 To Friedman, inflation occurred when
monetary policy was misused, pushing a country above its natural rate of unemploymentthat
level of voluntary unemployment which clears the labor market and which therefore produces a
real wage consistent with market equilibrium.79 When a countrys economy was stimulated to a
level higher than its natural rate of unemployment (through increases in aggregate demand from
increased government spending), prices grew faster than wages, meaning real wages fell.
However, laborers would not see the real wage as falling until they had already entered the
workforce because of increasing nominal wages. Therefore, workers would leave again as they
discovered the money illusion, bringing the economy back to the natural rate of unemployment,
but with a higher price level.80 In this way, Freidmans interpretation of the quantity theory of
money and its implications for inflation suggests that governments should not attempt to meddle
with the economy through Keynesian economic policy prescriptions (i.e. increased government
spending). Instead, Friedman advocated the implementation of automatic rules for adjusting the

75

Blaug, Economic Theory in Retrospect, pp. 646.

Ekelund and Hebert, A History of Economic Theory and Method, pp. 479.
77
Ibid.
78
Mark Skousen, The Making of Modern Economics, pp. 409.
79
Blaug, Economic Theory in Retrospect, pp. 681.
80
Ibid.
76

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money supply.81 This monetarist rule would require the legislature to grow the money supply at
a steady rate approximately equal to the nations economic growth rate.82 Such a rule would, in
theory, control inflation and smooth the business cycle.
While many economists criticized Friedmans view of economics and the policies
resulting from these ideas, it cannot be said that his insights were not important parts of
economic history. Before Friedman, Keynesian economics held a monopoly on economic
thought. However, Friedman and the monetarist school of economics were able to present
cogent arguments against the predominant Keynesian views. Many Keynesian economists
rejected monetarist policy pronouncements, but they would study the quantity theory of money
again. Keynesians would agree with monetarists that the quantity theory of money was valid for
long-run inflation, that money had real effects in the short run, and that these effects
changed depending on the way the money was created.83 That much of Friedmans work came
through a re-examination of the quantity theory of money demonstrates the importance of this
theory in economic development. By revisiting the quantity theory of money, Friedman was able
to make new assertions about the nature and importance of monetary policy as a tool in directing
a countrys economy. By taking a new look at the quantity theory of money, he ensured that the
theory would continue to influence ideas of economics in the present day.
Economists ideas and beliefs about money have changed over the ages, but the quantity
theory of money arises continuously. While its form and application changed from period to
period, it remains an important part of economic thought. Through the lens of the quantity
theory of money, one can see how economists of different eras dealt with the money markets and
interest rates. One can understand how different interpretations of the theory have led to different
81

Mark Skousen, The Making of Modern Economics, pp. 417.

Ibid.
83
Niehans, A History of Economic Theory, pp. 505.
82

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policy pronouncements. Through the quantity theory of money, one can realize how this theory
has affected the development of economic thought. From the mercantilists/pre-classical
economists to the monetarists, the quantity theory of money has been an essential tool in
understanding how money interacts with the economy. By tracing the quantity theory of money
through history, we can better comprehend how human society has developed, despite a difficult
world with finite resources.