Money

Abstract

THE first explanation is the oldest and is one which could have the all-pervading effects mentioned in the previous paragraph. It arises from a simple form of the quantity theory of money which provides for a direct relationship between the supply of money (and its velocity of circulation), the level of production and the level of prices. ‘Long period fluctuations [of prices] are chiefly caused by changes in the amounts of precious metals relative to the business which has to be transacted by them, allowance being made for changes in the extent to which the precious metals are able to delegate their functions to bank notes, cheques, bills of exchange and other substitutes.’¹ The argument was that despite the development of commercial banking, the supply of money in the 1870s and 1880s failed to keep pace with the growth of activity and prices consequently fell. A combination of circumstances slowed down the rate of increase of the world’s stock of gold upon which currency supplies were based. For one thing, after 1870 most of the major countries adopted the gold standard. There was a scramble for gold as each sought to build up its reserves so as to be able to maintain a fixed rate of exchange and allow free movement of gold in and out of the country.