Rethinking Monetary Policy with Reference to Monetary Circuit Theory

Standard monetary policy is grounded in the quantity theory of money, which links changes in the general price level to excess money that would induce excess demand on the goods market. This article shows that this theoretical foundation is misleading and harmful to growth. This is so because price determination is multifaceted. Central banks, especially the European Central Bank, currently tighten credit conditions whereas money is not an issue. In this way, they act not only on demand but also on the supply of goods. The additional reference made to rational expectations is an aggravating factor. Is there another way to conduct monetary policy? In this article it is argued that circuit theory, which endorses Keynes's dismissal of the quantity theory of money and his proposal to instead consider money flows in relation to the formation and spending of incomes, provides a substitute for standard monetary policy. Inflation and deflation could be avoided through a new structural arrangement of banks' monetary and financial operations.(This abstract was borrowed from another version of this item.)