Distribution of Money doesn't Matter

Third flaw of QTM is related to distribution of money in the economy. We first assumed that double the money in the economy but it all depends on who is going to take extra money and what will be done with it. If somebody gets the money and puts it in the bank and doesn’t do anything then doubling the money will have no effect in the economy. But if somebody gets the money and invest it in real economy then it can increase the productive capacity of the economy. If somebody gets the money and starts buying land with it then only land price will increase. If somebody gets money and starts buying stocks with it then stock markets index will increase due to it. So depending on who has the money and what will they do is very important. This idea that all prices will increase proportionally is not true at all. It can also be shown historically that it is not true. Distribution of money is all important but QTM says that distribution does not make any difference. According to QTM if money supply is doubled then prices will also double and it does not matter who gets the extra money. This is a common mistake and there is a reason for that i.e. in DSGE model there is only one consumer who is representative agent. So, if such economy where there is only one economic agent if money is doubled then prices will also be doubled and there will be no real effect as per QTM. But if there are two people in the economy and one of them is the miser and just stores the money in his bank then nothing will happen but if other one is investor or speculator and starts buying up all the land the prices of land will double but other prices will not and there will be a differential effect. It happens in Great Financial Crisis when bailout money is given to bankers and they started purchasing stocks and its prices gone up but the demand was not going up. So, third mistake of QTM is that distribution does not matter but actually distribution matters and if we want to tell what happens when the quantity of money is doubled then we can’t answer that question because we have to ask to whom the money will go and what will they do with it.

To explain the forth flaw of QTM first consider the specie flow mechanism of Hume. It is according to international trade so here assume that there is an open economy who trade with other economies. Specie flow mechanism has to do with Gold Standard so first go to Gold Standard for better understanding. Hume was the one who formulated the Quantity Theory. Specie flow is exactly in opposition to the mercantilist. The mercantilist said in order to economy functioning well we should have more and more gold and for it we must export more and get the gold while import less to save our gold. In mercantilist view trade must be only in luxuries. If there are luxuries and country is making money by its selling then its good and country should not import so many luxuries that are not useful. But Hume said that this mercantilist position is not true. Suppose that we start buying lot of goods from abroad then gold will go out and its result money supply will shrink. Now according to QTM the prices of goods in the economy will also go down and domestic goods will become cheaper as compare to foreign goods and other people will start buying. Gold that went out will increase money supply outside and it will also cause an increase in the prices outside so, foreign goods will become more expensive and we will buy less of them. At the end equilibrium will be restored. This is the so called Specie Flow Mechanism of Hume. Basically Hume was arguing that mercantilists are wrong and we don’t need to worry about the money supply because it will automatically take care of itself.

One thing that is important to understand is that mercantilist theory is right when it comes to society which is self-sufficient and trade only in luxuries. But when we move to a market economy there trade start taking place in necessities too. People grow food and also trade in it but if there come any trade problems then people have to starve as they will not have food to eat and it will not be a self-sufficient economy any more. In this case any restriction on trade will be harmful for the economy. In this scenario theory has to be changed to accommodate new type of an economy.