The Quantity Theory of Money

The hallmark of classical macroeconomic theory is the separation of real and

nominal variables. This classical dichotomy enables us to examine the behaviour
of the real variables in the economic system while ignoring the nominal
variables. In the stylized classical model we have developed, the quantity of
money is irrelevant for the determination of the real variables. Long-run
money neutrality is a crucial property of the classical model.
To explain the determination of the nominal variables in the system, the
classical economists subscribed to the quantity theory of money. A long line
of famous economists have either contributed to the development of this
theory or have been associated with its policy prescriptions. The list includes
Cantillon, Hume, Ricardo, Mill, Marshall, Fisher, Pigou, Hayek and even
Keynes. More recently the quantity theory of money has been associated with
the development of monetarism and the work of Milton Friedman, perhaps
the most influential economist in the past quarter-century. Although the term
monetarism did not emerge until 1968 (see Brunner, 1968), its main core
proposition, the quantity theory of money, was well established in classical
macroeconomics following the publication of David Humes influential essay,
Of Money, in 1752. Indeed, Mayer (1980) has argued that the salient date
for the birth of monetarist ideas was 1752, since most of the fundamental
propositions which characterize monetarism date back to Humes essay. Here
we will present only a short exposition of the quantity theory in order to
complete the classical scheme. For a more detailed discussion, see Laidler
(1991).