Keynes Contribution to the Quantity Theory of Money
Keynes contribution to the Quantity theory of money
The new theorists, in particular the Keynesians put importance that the worth of money or the level of price level is actually a result of the overall income more than amount of money.
In the case if less than full employment, an increase in the quantity of money is not likely to raise prices, while under full employment increase in the quantity of money will have the effect of raising prices. When the economy is working at less than full employment, an increase in money supply will normally lead to larger consumption demand and will also lower the rate of interest which, in turn, will stimulate investment. An increase in investment will, via the multiplier, raise aggregate demand. Now in order to meet the increased aggregate demand, more will be produced and to produce more, the unemployed factors of production will be employed. Thus, output, income and employment will increase, but prices are not likely to rise because of" the existence of unemployed resources which are willing to be employed at their ruling rates of remuneration.
However, as soon as full employment is reached, any increase in the quantity of money leading to an increase in the aggregate demand will not be able to evoke any appreciable increase in real output since no unemployed resources are available to add to production. Any increase in the quantity of money will only result in higher prices and rise in money incomes.
Sometimes even before the level of full employment is reached, prices maystart rising as a result of increase in money supply. This happens because of the emergence of 'bottlenecks' which hold up increase in production of goods.
Thus, the crux of the matter is whether output in the economy is elastic or inelastic when supply of money is increased. If it is elastic, prices need not rise, and prices must rise if output is inelastic. In conditions of less than full employment, output is generally elastic, while under full employment it is inelastic. Hence, different results follow in respect of prices as a result of changes in the quantity of money under (a) less than full employment and (b.) full employment.