Quantity theory of credit

History
A document entitled ‘The Quantity Theory of Credit’ was first issued by Richard Werner in 1992, when he was a doctoral student at the University of Oxford. As he presented a paper with this title to colleagues at Oxford and at the Royal Economic Society in York in April 1993, he was advised to ‘tone down’ the claim of having developed a theory, to increase the chances of the theory being accepted by other economists. While Werner continued to refer to his theory as the Quantity Theory of Credit in various documents, presentations or correspondence in later paper submissions to conferences, such as the Asia-Pacific Capital Markets conference (PACAP) in Kuala Lumpur in June 1993, and to journals, he modified the name to the ‘Quantity Theorem of Credit’, and, further specified in academic fashion, the ‘Quantity Theorem of Disaggregated Credit’. Meanwhile, the content of the theory has remained the same since 1992. However, subsequent work has added a substantial body of empirical evidence and practical applications of the theory, for instance for monetary policy advice or forecasting in asset management.
In 1994, Richard Werner became chief economist at Jardine Fleming Securities (Asia) Ltd. and presented his ‘Quantity Theory of Credit’ to fund managers and asset management professionals all over the world, averaging over 300 client presentations per year until 1997. He founded the Profit Research Center Ltd. in 1998, a research and fund advisory firm that has focused on the application of Werner’s Quantity Theory of Credit. It has, among others, sold its research to Soros Fund Management Ltd., New York. In 1996 Werner launched the Bear Stearns Global Alpha Fund as senior portfolio manager and senior managing director, basing the fund management entirely on his Quantity Theory of Credit. Today, Werner acts as fund advisor and fund manager at Providence Asset Management Ltd., Winchester, employing the Quantity Theory of Credit to manage international portfolios, including global macro funds. Much of his academic work has employed the quantity theory of credit as well as his policy advice: in 1994 he suggested in Japan to create a recovery by expanding the quantity of credit, which he referred to as Quantitative Easing (QE).
Content
The main content of the Quantity Theory of Credit can be seen in the shortened version of the original paper, which was published in 1997 in the German leading monetary economics journal ‘Kredit und Kapital’ (although published in the English language; the German title refers to the quantity 'theory', not 'theorem'). It is available online at http://eprints.soton.ac.uk/36569/.
Werner considers the conventional ‘quantity theory of money’, also known as the ‘equation of exchange’:
MV PY (or: Money times Income Velocity prices times real GDP, i.e. nominal GDP)
and identifies two flaws that have resulted in a number of noted problems (or ‘anomalies’), namely the definition of ‘M’ in this formulation, and the claim that all money is used for GDP-transactions.
He points out that the original equation referred to transactions:
MV = PT
(using Fisher’s, 1911, notation; or MV=PQ, using the notation of Werner in later writings, whereby PT and PQ refer to the volume of transactions).
Werner then proceeds to point out that money ‘M’ should never have been measured with the standard monetary aggregates, since they measure savings - money out of circulation, not money in circulation, as required by a transactions equation. He argued that since the money supply is created through the process of credit creation (by the central bank and the banks), a correct measure of M is credit C, which, when growth rates are calculated, also gives an indication of the amount of money actually used for transactions.
Hence Werner’s most basic formulation of the Quantity Theory of Credit:
CVPT (or CVPQ)
(see, for instance, Werner, 2005, p. 190; or 2011 ).
Werner then proceeds to explain one of the major ‘puzzles’ or anomalies in modern macroeconomics, namely the apparent ‘velocity decline’ in the original conventional formulation of the quantity equation. He points out that equation 1 is actually incorrect, since not all money is used for GDP transactions. Hence he disaggregates credit-money flows into those funding transactions that contribute to GDP, and those that do not (namely financial or asset transactions) - noted with subscripts R and F for real and financial circulation, respectively.
C = CR + CF
CRVR PRTR (or PRQR) PRY (or nominal GDP)
CFVF = PFTF (or PFQF)
Citations
Richard Werner's quantity theory of credit was prominently discussed in the Economist in June 1993.
In 1995, Renaud Bertrand quoted Werner's quantity theory of credit paper presented at the Royal Economic Society annual conference.
In 1998, Werner (1998) wrote as follows: “Werner (1997) shows that the standard "quantity theory" monetary model is a special case of a more general "quantity theory of disaggregated credit".”
In his bestselling book Princes of the Yen (M. E. Sharpe, 2003; in Japan for six weeks a number-one general bestseller outselling Harry Potter), Werner wrote on page 288, footnote 21 that the old ‘quantity theory of money’ “would really have to be re-labelled the quantity theory of credit” (Werner, 2003). With this he referred to the theory he himself first developed in 1992 and published over the years in many publications, which also present detailed econometric evaluation and empirical support for his theory.
Richard Werner's book New Paradigm in Macroeconomics restates, elaborates and empirically tests further the quantity theory of credit in some detail.
In his 2009 article in QFinance, which has been widely disseminated, Werner explains the quantity theory of credit in non-technical terms.
Huertas (2010) asks whether the 'quantity theory of credit' makes sense and comes out largely supportive.
In this dissertation Stoop studies Werner's 'Quantity Theory', see e.g. on page 39ff.
UK Financial Services Authority Chairman Lord Turner largely applied Werner's quantity theory of credit and some of the policy advice, such as in his Winchester speech of 29 September 2011.

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