Criticism of Transaction Approach

The quantity theory of money has been widely criticized. The main criticism are the following:

(1)    The Theory is based upon unreal assumptions. Fisher has assumed the quantity of bank money (M), velocity or circulation of the bank money (V’), velocity o circulation of legal lender money (V), and the total volume of transaction (T) as constant during the short-run, which is not proper. If the quantity of money remains unchanged but its velocity increases, then the prices are bond to increase. Similarly, change in the level of production also influences the general price level.

(2)    Money supply and price level are not directly Prof. Keynes is of the opinion that the relationship between the quantity of money and the price level is not so direct and immediate as assumed by Fisher. In his view, the change in the quantity of money influences the price level in the following way:

Change in             Change in             Change in               Change in the money    →     the rate of     →      investment    →      the income                                 interest                                                          and                                                                                                      employment Change in    →     Change in    the cost of              the price production               level

(3)    Prices also affect money supply. It is wrong to assume price level as a passive element in the equation of exchange. A change in P may cause in M. High price level may activate economy and this may necessitate the issue of more money. The reverse is equal true.

(4)     Inclusion of inconsistent factors in the equation. In Fisher’s equation, M denotes the supply of money at a ‘point of time’, while V denotes the velocity of circulation during a ‘period’. The multiplication of M and V will give us inconsistent results.

(5)    Limited application of the theory. Fisher’s theory fails to sustain the test of time. During the period of depression even if there is no reduction in the quantity of money price level is bound to fall.

(6)    Non-monetary factors ignored. Prof. Fisher himself has agreed that there are many other factors besides money which influence the price level-factors like the diversity of human want, decentralization of industries, development of the means of transportation, propensity to consume, etc.

(7)    Proportional relation between money supply and price level does not exist. It is not always necessary that the price level must change exactly in the same proportion as the supply of money. it is only at the full employment level that money supply affects the price level proportionally. but full employment is simply  a myth.

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