Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Fisher and Wicksell on the Quantity Theory

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Fisher and Wicksell on the Quantity Theory

Article excerpt

The quantity theory of money, dating back at least to the mid-sixteenthcentury Spanish Scholastic writers of the Salamanca School, is one of the oldest theories in economics. Modern students know it as the proposition stating that an exogenously given one-time change in the stock of money has no lasting effect on real variables but leads ultimately to a proportionate change in the money price of goods. More simply, it declares that, all else being equal, money's value or purchasing power varies inversely with its quantity.

There is nothing mysterious about the quantity theory. Classical and neoclassical economists never tired of stressing that it is but an application of the ordinary theory of demand and supply to money. Demand-and-supply theory, of course, predicts that a good's equilibrium value, or market price, will fall as the good becomes more abundant relative to the demand for it. In the same way, the quantity theory predicts that an increase in the nominal supply of money will, given the real demand for it, lower the value of each unit of money in terms of the goods it commands. Since the inverse of the general price level measures money's value in terms of goods, general prices must rise.

In the late nineteenth and early twentieth centuries, two versions of the theory competed. One, advanced by the American economist Irving Fisher (1867-1947), treated the theory as a complete and self-contained explanation of the price level. The other, propounded by the Swedish economist Knut Wicksell (1851-1926), saw it as part of a broader model in which the difference, or spread, between market and natural rates of interest jointly determine bank money and price level changes.

The contrasts between the two approaches could hardly have been more pronounced. Fisher's version was consistently quantity theoretic throughout and indeed focused explicitly on the received classical propositions of neutrality, equiproportionality, money-to-price causality, and independence of money supply and demand. By contrast, Wicksell's version contained certain elements seemingly at odds with the theory. These included (1) a real shock explanation of monetary and price movements, (2) the complete absence of money (currency) in the hypothetical extreme case of a pure credit economy, and (3) the identity between deposit supply and demand at all price levels in that same pure credit case rendering prices indeterminate.

Despite these anomalies, Wicksell was able to derive from his analysis essentially the same conclusion Fisher reached. Both concluded that the monetary authority bears the ultimate responsibility for price level stability, a responsibility it fulfills either by determining some nominal variable-such as dollar price of gold, monetary base, bank reserves-under its control or by adjusting its lending rate in response to price level deviations from target.

The story of how Fisher and Wicksell reached identical policy conclusions from seemingly distinct models is instructive. It reveals that models appearing to be substantially different may be only superficially so. In the case of Fisher and Wicksell, it reveals that their models may not have been as dissimilar as often thought. Indeed, the alleged non-quantity-theory elements in Wicksell's work prove, upon careful examination, to be entirely consistent with the theory. In an effort to document these assertions and to establish Wicksell's position in the front rank of neoclassical quantity theorists with Fisher, the paragraphs below identify the two men's contributions to the theory and show how their policy conclusions derived from it.

1. FISHER'S VERSION OF THE QUANTITY THEORY

In his 1911 book The Purchasing Power of Money, Fisher gave the quantity theory, as inherited from his classical and pre-classical predecessors, its definitive modern formulation. In so doing, he accomplished two tasks. First, he expressed the theory rigorously in a form amenable to empirical measurement and verification. …

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