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Keynes' position on Money and Inflation - a note

Hector McNeill1

Many monetarists insist in promoting the fallacy that money volumes have a direct impact on inflation. Our research into RIO (Real Incomes Objective) provides explanations why this is not the case. John Maynard Keynes' own position was similar to that of RIO.

Keynes contributed to the Cambridge Quantity Theory of Money equation but this omitted one of the most obvious causes of inflation, assets.

Inflation of what?

As a society people are concerned with the purchasing power of their nominal incomes therefore the basic concern of policy is to avoid inflation in goods and service consumption markets, and including capital items such as equipment.

Money and inflation

Keynes position on the impact of money volumes on inflation was that associated with higher money volumes interest rates fall leading to investment and increased production and it is this process that ends up being associated with rising unit prices. Although not detailed there are many ways to explain this. In new products there is a desire to recoup development costs e.g. new iPhones. The learning curve effect and scales of production impacts on unit costs only come into force after a time so a small price hike is followed by a slow decline in unit costs. The pricing effect here depends upon the marketing strategy of different enterprises.


The Cambridge Equation was an improvement on the standard Quantity Theory of Money because it included savings as a non-circulating component of money volume. This has the effect of reducing the money volume in transactions. However, this still left out assets (land, real estate, precious metals, rare objects, selected commodities, stocks and shares). The other significant form of non-circulating money has been offshore investment which, of course, has also depressed employment onshore. This was corrected to create the Real Money Theory II identity to include savings, assets and offshore leakage which can be used to simulate the depressive impact of non-circulating funds on the supply side production and wage-earning sector cash flow.

As has become self-evident, under quantitative easing, the increase in low interest money has created a massive inflation in asset markets which are creating inflationary leakage through house and land prices and rents into the goods and services consumption markets on an economy which has exported employment to offshore locations only exacerbates the impact of monetary policy in stimulating cost-push inflation. Note that money supply is not "increasing demand". In reality the number of encapsulated markets that absorb money injections into non-cirmulating categories is some 9 entities or 9 quantiative variables and the QTM consists of 4 variables in which M is a black box."

In short, the QTM direct linkage between money volume and inflation is incorrect and therefore provides no quantitative means of tracing the mechanism which, in turn, means it cannot be used to model and simulate in order to quantify this effect.

1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.

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