money, quantity theory

money, quantity theory of

Economic theory relating changes in the price level to changes in the quantity of money. It has often been used to analyze the factors underlying inflation and deflation. The quantity theory was developed in the 17th and 18th centuries by philosophers such as John Locke and David Hume and was intended as a weapon against mercantilism. Drawing a distinction between money and wealth, advocates of the quantity theory argued that if the accumulation of money by a nation merely raised prices, the mercantilist emphasis on a favourable balance of trade would only increase the supply of money without increasing wealth. The theory contributed to the ascendancy of free trade over protectionism. In the 19th–20th centuries it played a part in the analysis of business cycles and in the theory of rates of foreign exchange.