What Is Theory Of Money Analysis?
Money is subject to numerous forces and is itself capable of impacting lives. Money analysis theory, therefore, talks about these factors and how the supply of money can grow economies or cause their downfall. In this article, we discuss three theories on money and what they mean in the financial world.
Quantity Theory Of Money
The quantity theory of money (QTM) correlates the prices of goods and services and the amount of money available in a particular economy. It alludes to a direct proportionality. It states that doubling in the quantity of money in an economy causes inflation since the prices also double. A consumer, therefore, has to pay double the original price yet the amount of goods remains constant. The QTM is crucial for individuals involved in trading goods such as oil.
The theory treats money as a commodity. In this regard, it is subject to the laws of demand and supply. The higher the amount of cash in the market, the lower the purchasing power of that particular banknote.
The QTM can be summarized by the Fisher Equation. The quantity of money theory is as follows:
- M is the supply of money in an economy.
- V is the velocity of money, that is, the rate at which money is exchanged from one individual to another.
- P is the average price of goods and services
- T is the total transactions in the economy.
The QTM was popularized by Irving Fisher in his 1912 book called “The Purchasing Power of Money: Its Determination and Relation to Credit Interest and Crisis”. It is considered a force in economics and paved the way for the understanding of the relationship between money and goods vis-à-vis their prices. Since then, economists have come up with other theories about money.
Monetary theory, on the other hand, postulates that changes in the supply of money impact economic activities. It espouses the power of central banks which are mandated with the task of comping up and enforcing monetary policies. By regulating the amount of money now in circulation, they are able to control the growth of the economy.
The Modern Monetary Theory Explained
Monetary theory subsequently birthed modern money theory, also known as the modern monetary theory (MMT). The latter relates to the understanding that countries such as the United States of America (USA), the United Kingdom (UK), Canada, and Japan have a monopoly when it comes to issuing currency. They do not have to rely on revenue collections or taxes since if they experience a deficit, they can print more money. This means that they can make money.
These monetarily sovereign countries, therefore, are not subject to the principles of the QTM. Essentially, it implies that nations cannot deplete money as businesses and individuals can. Notably, investors should choose these currencies whenever they intend to invest.
Difference Between Money Analysis Theories
Theories about money include the quantity theory of money (QTM), monetary theory, and the modern money theory (MMT). The first relates to the relationship between money and the prices of goods. It states that an increase in the supply of cash causes inflation. The second indicates that central banks can use monetary policies to improve the economies of their respective countries. The third theory alludes to the sovereignty of some nations’ currencies. That they can print money to solve financial deficits without causing a negative impact on the economy.
This is one of money analysis theories, which considers, that the amount of money and expenses in economy are in direct proportion. The more money exists, the higher prices become and vice versa.
There are 2 main points. The first states that increasing prices is a consequence of inflation. The second considers that only a government can be a money issuer. Thus, the MMT explains that everything that happens with money should be regulated by government.