Development Theory – The Quantity Theory Up To The 19th Century
Year Bodin’s monetary theory of price inflation about the mid 16th century in western Europe goverment marked the beginning of the main theory and outlines of the quantity theory of money and the development theory. Subsequent writers confirmed and extended Bodin’s hypothesis with other well known scholars by postulation states that the value of purchasing power of money varies in exact proportion to the quantity in circulation such that M which stands for (money) is doubled, P which stands for (price) will also double while the value of the monetary unit will be halved.
As a proportionality postulate, it was regarded as an identity. In its first statement in 1691 by John Locke, the postulate asserted that P (price) is always proportional to M. In 1752 David Hume introduced the notion of causation which we have seen earlier and which states that variation in M will cause proportion was in terms of comparative static analysis that only valid for comparing the states of old and new monetary equilibrium after the economic system had fully adjusted to a change in the money stock.
Richard Cantillon and David Hume, both writing in the 18th century applied to the development theory and the quantity theory two important and its basic distinctions.
- Between economic static long run stationary equilibrium and short run movement towards equilibrium and
- Between long run neutrality and the short run non neutrality of money. They explain the sequence of steps by which the impact of a monetary change spreads from one sector to of the economy to another, enhancing relative prices and quantities in the process.
To these arbiters adjustment will continue until all process had changed in equal proportion to the money stock and all quantities had returned to their pre exiting levels which they were estimated to be at on the previous level. They also had short run neutrality accounts of monetary changes. Here cantillon pointed out that the dynamic injected into the system arguing that the generally new money will not be distributed among individuals among individuals in proportion to their pre-existing share of money holdings.
Rather some will receive more and others less than their proportionate change. The former will benefit more than the latter and to that extent will influence in a greater way, the determination of the composition of output.
David Hume describe how different degrees of money illusion among income recipients coupled with time delays in the adjustment, he advised that the process could cause cost to lag behind prices thus creating profits and stimulating and formation of optimistic expectations would spur business expansion and employment during the transition period. There non neutral effects were expected to disappear in the long run.
The Early 20th Century (Development Theory)
Economist of the early 20th century furthered the traditions of the 19th century classical economists. They held also that the price level is determined by the volume of money, that relative prices are determined by the supply of and demand for commodities and that full employment is the normal state of the economy since the circulation of money in the economy determines the strength and size of the country’s economy. Their two most prominent contributions to monetary theory and the Development Theory however were;
- They formulated alternative analytical approaches to explaining the economic role of money; the fisher transactions equation of exchanges and the famous Cambridge cash balance equation are examples of their Development Theory or the development of monetary theory as a framework of analysis.
They made renewed attempt to understand the role of money in short term cyclical fluctuations even though there was only a little effort in verifying their hypothesis empirically.