Fisher and Wicksell on the Quantity Theory

T he 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.