In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply. The theory was originally formulated by Polish mathematician Nicolaus Copernicus in 1517, and was influentially restated by philosophers John Locke, David Hume, Jean Bodin, and by economists Milton Friedman and Anna Schwartz in A Monetary History of the United States published in 1963.
The theory was challenged by Keynesian economics, but updated and reinvigorated by the monetarist school of economics. Critics of the theory argue that money velocity is not stable and, in the short-run, prices are sticky, so the direct relationship between money supply and price level does not hold. In mainstream macroeconomic theory, changes in the money supply play no role in determining the inflation rate. In such models, inflation is determined by the monetary policy reaction function.
Alternative theories include the real bills doctrine and the more recent fiscal theory of the price level
Principles
The theory above is based on the following hypotheses:
- The source of inflation is fundamentally derived from the growth rate of the money supply.
- The supply of money is exogenous.
- The demand for money, as reflected in its velocity, is a stable function of nominal income, interest rates, and so forth.
- The mechanism for injecting money into the economy is not that important in the long run.
- The real interest rate is determined by non-monetary factors: (productivity of capital, time preference).
Alina Mija 