Informedness of Economic Agents and the Quantity Theory of Money

Historically, informed of economic agents via price stability has been a rationale for the money supply rule derived from the Quantity Theory of Money. Since monetarists maintain that changes in the price level are attributable to the level of the money supply, the general price level index is used as the basis for the periodic adjustment of the short-term interest rate to curb inflation. In so doing, agents are informed of expected price level changes. From a relativist perspective, in the absence of monetary dislocation or revaluation, changes in the general price level are attributable to the net effect of the realignment of relative prices which are caused by factors other than the level of the money supply. Since the price level index is a mental construct, which is devised to capture the changing conditions in economic growth for the purpose of physical productivity analysis, it is doubtful that it can be an adequate guide for monetary policy. If changes in the general level of prices are not a function of changes in the supply of money but of changes in the composition of aggregate demand and supply, then the money supply rule for monetary policy would be ineffective at best and disruptive at worst. Apart from adverse financial impacts on business, the 'quantity theory' inflation-designed short-term interest rate policy has induced significant negative effects on the capital markets in 1987 and in 2006. There is a definite need to focus on other factors that are accountable for the changes in the level of prices