The identities for the Quantity Theory of Money, the Cambridge Equation and the Real Money Theory all contain the variables for money volume M, velocity of circulation V and real incomes Y. As follows:
QTM:M.V = P.Y
The Cambridge Equation:
(M-s).V = P.Y
(M - (l + r + p + m + a + h + f + c + o + s)).V = P.Y
Where for all identities: M is money volume; V is the velocity of money circulation; P is the average price of goods and services; Y is real income; l is land; r is domestic and commercial real estate; p is precious metals; m is commodities; a is art objects; h is shares; f is financial instruments; c is crypto-currencies; o is offshore flows and s is savings.
M or money volume
Money is a the unit of account applied to different types of transaction involving different products. There is an important distinction between assets, offshore flows, savings and consumer goods and services. There is therefore a distinct lack of clarity in terms of policy objectives in managing M in taking into account so many different possible impacts of M
. Policy makers tend to only discuss prices in the context of goods and services since these affect the cost of living. However, M is simply a pool of funds
which takes on different forms according to its role in very different "markets" leading to an undermining of the logic of the QTM and Cambridge Equation.
V or money velocity
Most of the asset markets are encapsulated in the sense that money rotates within those markets with buying and selling prices being related to speculative flows of M into them and draining such funds from goods and services transactions. This is why under quantitative easing the velocity of circulation within goods and services declined significantly. This provides a possible explanation for the paradoxical demand depressive effect for goods and services resulting from QE.Y as real income
The volume of transactions for goods and services is more correctly expressed as the product of average unit prices and the quantities of goods and services transacted or P.Q where Q is the number of transactions. Therefore the total income spent on goods and services, Y is more correctly expressed as Y = P.Q. This allows any differentials in disposable incomes Y to be better exposed by making Q real incomes i.e. the quantity of goods and services people are able to purchase and P remaining as the average price. Y is nominal wages and incomes whose purchasing power is affected by P to generate Q. A further development of this thread can be used to relate wages to the productivity levels of companies Y = P.Q
substituting P.Y with P.Q
(M - (l + r + p + m + a + h + f + c + o + s)).V = P.QSo what?
The Real Incomes Approach depends upon a sound understanding of the factors that determine real incomes. These have already been established in several articles and in the Special Edtion of the British Strategic Review, Monetarismn and the Cost of Living
. However, it is very apparent just how confusing monetary policy is on this question of real incomes. This is caused by the monetary logic resting on such identities as the QTM which provides no guidance on such essential relationships. Even with the elaboration of the current state of the RMT, this remains a challenge because monetary logic is unable to handle the mechanisms involved, that is delineating or providing a specific determinate function of cause and effect, in the real economy. Esoterics as beyond the pale economics
In the end, presenting economic questions as stark identities and mathematical equations is not a way to communicate fundamental facts and relationships of importance to constituents. The function of economists needs to become one of an honest counsel identifying what is not understood while providing the most rational advice, on the basis of known facts, what should work and incur less risks to constituents. Unfortunately, much economic expression is esoteric and understood by few but at the same time it is often irrelevant to the concerns of constituents to the degree of being damanging and prejudicial when applied as the logic to justify economic policies. Thus the assumed sophistication of such esoterics can become a form of "beyond the pale" economics, something that constitutes a corrupted logic and unacceptable basis for taking decisions. In the end we need to accept that there is nothing more productive and beneficial as a robust theory. So far, in this analysis, monetary policy and monetarism, in general, do not seem to qualify on this basis. There are so many suppositions as to render it to be unreliable. Conclusion
This short review of three factors in the QTM, Cambridge Equation and RMT have significant theoretical implications which are beyond the objectives of this short note. However as a result of the RMT now having appeared in several articles and reviews based on a somewhat atomized presentations, the DIO has asked if I would produce an update on the original paper published by them in 2020. This update will bring together a consolidated version of the RMT in order to update the current understanding of a useful form as well as to point out the theoretical and practical ramifications for economic policies.
At first sight, the small advances in knowledge represented by the various baseline RMTs, further undermines the QTM as a reliable representation of any monetary theory or justification for any national policy. The most obvious barrier is the needed integration of the processes of price setting by companies, which currently is impossible with the QTM, Cambridge Equation and the RMT. This strengthens the contention that monetarism is a policy with no theory because, so far, evidence establishes this to be an almost certain fact. Price setting is determined exclusively by the adjustments made by thousands of companies in response to their specific conditions and, in particular, to their input costs and the existing purchasing power of consumers they serve. These two factors point to the likely route (input cost price effects and income-price2
elasticity of demand) to be able to trace the real impacts of money volumes on corporate price setting and the resultant average prices of goods and services.
A DIO update covering the latest status of the RMT accompanied by a less esoteric format in the form of a more detailed accompanying narrative will be posted, following its final review, by mid-October 2022.
1 Hector McNeill is director of SEEL-Systems Engineering Economics Lab.
2 The price elasticity of demand of goods and services varies with disposable income levels. Therefore to indicate that the price elasticity of demand needs to be stratified according to disposable income levels, this type of analysis is indicated by the phrase, income-price elasticity of demand
Update (12/10/2022): The delivery date of the RMT update has been moved from mid-September to mid-October due to ongoing work demands.
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