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Knut Wicksell (1851 - 1926) (image source: https://mises.org/profile/knut-wicksell-0] Knut Wicksell's major contribution was his attempt to explicate economic instability on the basis of differences between the "natural" rate of interest (return on new capital) and the "market" rate of interest (what banks charge). This discrepancy between the two interest rates has been called the "Wicksell's differential." Wicksell's view is that if the market rate of interest equals the natural rate of interest, this results in price and economic stability. Wicksell's basic idea is: if the market rate of interest increases and becomes greater than the natural rate of interest, this results in a decrease in prices. Conversely, if the market rate of interest falls and becomes lesser than the natural rate of interest, economic activity increases, prices also increase. Because of the cumulative process that stems from the discrepancy between the natural rate of interest and the market rate of interest, Wicksell proposed two (2) rules for a central bank to stabilize the price level: 1.) direct policy makers to adjust the market rate of interest in the same direction that prices are moving until the price movements stop; and 2.) the central bank to adjust the bank rate until prices return to a fixed target level. Unlike the first rule which seeks a stop to price changes, the second rule seeks to reverse these price changes. The Wicksellian differential is derived from Knut Wicksell's theory of interest and is.an. approximation of disequilibrium in the economy. With the existence of credit money Wicksell claimed two (2) rates of interest: 1.) natural rate of interest which is the return on capital, the real rate of interest, and which is equivalent to the marginal product of capital; and 2.) money rate of interest which is the loan rate. Credit is perceived as money as banks provide deposits on which borrowers can withdraw upon. Since deposits constitute part of real money balances, in essence banks can create money. Wicksell argued that equilibrium of a credit economy could be ascertained by comparing the money rate of interest to the natural rate of interest. In modern technology this involves comparing the cost of capital with the return on capital. In economies where the natural rate of interest is higher than the money rate of interest, credit growth will drive a positive equilibrium inthe economy. When the natural rate of interest is lesser than the money rate of interest, the demand for credit drives up to a negative equilibrium in the economy. Wicksell's main thesis is that the disequilibrium engendered by real changes leads endogenously to an increase in the demand for money and simultaneously an increase in the supply of money as banks try to accommodate the demand for money. Thus, given full employment (a constant volume of output(Y) and constant payments structure (V)), then in terms of the equation of exchange: MV = PY; an increase in money supply (M) would result in an increase in the price level (P).Irving Fisher (1867 - 1947) (image source: https://en.wikipedia.org/wiki/Irving_Fisher#/media/File:Irvingfisher.jpg) Irving Fisher was one of the earliest American Neo-Classical economist. He made important contributions to utility theory and general equilibrium. His research on the "Quantity Theory of Money" inaugurated the school of thought on monetarism. He is best known for the "Fisher Equation" which was based on the "Quantity Theory of Money."Fisher's Equation of Exchange Fisher's Equation: W = PT where M = total stoclc of money; P = price level; T = attempt of transactions carried out using money; and v = velocity of circulation of money. Irving Fisher used the equation of exchange to develop the classical \"Quantity Theory of lvloney", a causal relationship between the money supply and the price level. Based on the 45 assumptions that, in the long run, under full employment conditions, total output {T} does not ct]_ang and the transactions velocity of money {V} is stable, Fisher was able to demonstrate a causal relationship between money supply and the price level. Thus, the M Theory of Money\" states that v and T heing unchanged, changes in money supply cause a direct and proportional change in the price level. Fisher further extended the equation of exchange to include demand {panic} deposits represented by M' and their velocity [V] in the total supply of money [MEdE'l, p.61T}. Thus, the equation of exchange oecomes: my + my\" = PT. According to Fisher, the level of general prices {P} depends exclusively on ve (5] factors: 1 .] lvl = volume of money in circulation; 2.] v = velocity of money in circulation; 3.] M' = volume of hanlc deposits; 4.} V\" = velocity of circulation of M'; and 5.} T = volume of trade. To reiterate, the assumptions of Fisher's Theory which are: 1. Constant velocity of money (V) Constant volume of trade or transactions 3. Price is not the cause but the effect 4. Money is a medium of exchange 5. Constant relation between M and M' Currency money (M) and bank money (M') assume a proportional relationship 6. Long run period where V and T are constant Thus, when M', V, V and T are constant over time and P is a passive factor, it follows that a change in the money supply will lead to a direct proportional change in the price level. This transactions approach to the "Quantity Theory of Money" maintains that other things remaining the same, if V, M', V, and T remain unchanged, there exists a direct and proportional relationship between M and P. If the quantity of money is doubled, the price level will also be doubled and the value of money which is 1/P, will be halved; if the quantity of money is halved, the price level is also halved and the value of money is doubled. Policy Implications of Fisher's Quantity Theory 1. Under equilibrium conditions of full employment, the role of monetary (or fiscal policy) is limited. 2. During temporary disequilibrium period of adjustment, an appropriate monetary policy can stabilize the economy. 3. The monetary authorities by changing the money supply, can influence and control the price level and the level of economic activity of the country. Fisher's main intellectual rival was Knut Wicksell. Fisher espoused a more explicit explanation of the "Quantity Theory of Money", resting it on long run prices. Although both Wicksell and Fisher concluded from their theories that at the heart of the business cycle and economic crises was government money policy, their disagreement spilled over to the policy debates between the Keynesians and the Monetarists.1. Distinguish and explain between the natural rate of interest and the market rate of interest from Wickselt's perspective. Explain the effect of the discrepancy between the market rate and natural rate of interest on the general price level. Explain Irving Fisher's Equation of Exchange and Policy Implications of Fishefs Quantity Theory. Discuss and explain the relationship of monev supply and the general price level using the Fisher Equation