A Reinterpretation of Classical Monetary Theory

Abstract

Relevance to current policy issues is usually not the motivation for studying the history of economic theory. However, questions about the practicality of conducting monetary policy in a deregulated financial system by controlling the monetary aggregates are stimulating interest in convertibility as an alternative to our present monetary arrangements [3; 6; 66]. Since classical writers were mainly concerned with monetary theory and policy under a gold standard, it is to be expected that renewed attention will be devoted to classical monetary theory. My aim in this paper is to show that, contrary to received views about classical monetary theory, it was not based on the quantity theory of money. On the contrary, it was based on a theory of a convertible, competitively produced money supply that was fundamentally different from the quantity theory. Using the modern theory of a competitive money supply, we can now rigorously derive many of the basic propositions of classical monetary theory that have been denied or misunderstood by modern theorists operating within the framework of the quantity theory. Received views about classical monetary theory can be summarized by the following propositions: