Tooke’s theoretical system
The Currency School, following the lead of David Ricardo, adopted the quantity theory of money as their basic model of how prices react to changes in the money supply. However, Ricardo developed his monetary theory during the restriction of cash payments, when the pound sterling was not convertible.
The Currency School continued to use the quantity theory as their basic model of how changes in the supply of convertible currency would affect prices. Tooke and other members of the Banking School rejected the quantity theory as a valid approach to understanding how a convertible currency actually worked. In sharp contrast to the Currency School’s approach, Tooke argued that the quantity of money, consisting of all different kinds of monies, was endogenously determined by the price level and the level of output. Hence, causation ran from the price level to the quantity of money, including the quantity of banknotes. Tooke also maintained that short-run changes in the interest rate had little effect on the level of expenditures, but that the “long-run average” rate of interest - which governed the normal rate of profit - was determined in the financial market by politico-institutional and conventional factors, largely independent of Bank of England policy (Smith 2003: 46-7). Tooke’s theory drew on Adam Smith’s concept of two circulations: wholesale and retail.