Connecting Fisher’s Equation to the Quantity Theory of Money Flashcards
What is Fisher’s Equation of Exchange?
M * V = P * Q
Where M = Money supply, V = Velocity of money, P = Price level, Q = Real output (real GDP)
What does the Quantity Theory of Money (QTM) build on?
Fisher’s Equation of Exchange
QTM expands upon the relationships outlined in Fisher’s Equation.
What assumption does the Quantity Theory of Money make about velocity (V)?
Velocity (V) is stable
Money circulation habits change slowly.
What determines real output (Q) according to the Quantity Theory of Money?
Real factors:
* Productivity
* Technology
* Labor
These factors influence the overall output of the economy.
What happens to price level (P) if money supply (M) increases while real output (Q) is constant?
Leads to a proportional increase in P (inflation)
This reflects the relationship between money supply and inflation in the QTM.
What is the key argument of Milton Friedman regarding inflation?
Inflation is always and everywhere a monetary phenomenon.
What is the primary cause of inflation according to monetarists?
Excessive money supply growth.
What factors are considered secondary in the cause of inflation?
Demand-side factors and wage-price spirals.
What is the policy prescription for controlling inflation according to monetarists?
Control inflation via steady, predictable expansion of money supply aligned with real GDP growth.
Which UK leader implemented monetarist policies in the 1980s?
Margaret Thatcher.
What was Paul Volcker’s role regarding monetarist policies in the 1980s?
He targeted money supply to combat inflation as the US Federal Reserve Chair.
What challenge did monetarist policies face in the 1980s?
Instability in money demand led to a shift from monetary targets to interest rate targeting.
What event in Weimar Germany led to hyperinflation from 1921 to 1923?
Excessive money printing to pay WWI reparations
This period is characterized by extreme devaluation of the currency due to the government’s financial policies.
When did hyperinflation peak in Weimar Germany, and what was the exchange rate at that time?
November 1923: 4.2 trillion Reichsmarks per US dollar
This extreme devaluation illustrates the consequences of excessive monetary expansion.
What was the inflation rate in Zimbabwe in 2008?
89.7 sextillion percent per month
This staggering rate led to the currency becoming worthless and a reliance on foreign currencies.
What actions did the Zimbabwean government take that contributed to hyperinflation?
Printed money to finance deficits
This strategy resulted in severe economic instability and loss of currency value.
What factors contributed to hyperinflation in Venezuela during the 2010s?
Excessive money supply growth, collapse in productive output, lack of confidence in the domestic currency
These factors combined created a severe economic crisis leading to hyperinflation.
What was the inflation rate in Venezuela in 2018?
Over 1,000,000%
This astronomical figure reflects the extreme economic turmoil faced by the country.
Fill in the blank: Hyperinflation in Weimar Germany peaked in _______.
November 1923
True or False: Zimbabwe’s government printed money to finance its budget deficits, leading to hyperinflation.
True
Fill in the blank: Venezuela’s hyperinflation in the 2010s was characterized by a lack of _______ in the domestic currency.
confidence
What does the Quantity Theory of Money suggest about excessive money supply growth?
It causes severe inflation.
This is confirmed by historical hyperinflations.
What are the policy implications of the Quantity Theory of Money?
Framework for central bank monetary policy including:
* Inflation targeting
* Monetary base control
These strategies help manage inflation effectively.
What is an example of a successful inflation-targeting regime?
Bank of England’s 2% inflation target in the 1990s-2000s.
This illustrates the monetarist legacy of successful inflation control.
True or False: Historical hyperinflations provide empirical support for the Quantity Theory of Money.
True.
They demonstrate the direct link between money supply and inflation.
Fill in the blank: The Quantity Theory of Money is a framework for _______.
[central bank monetary policy].
This includes strategies like inflation targeting and controlling the monetary base.
What do Keynesians argue about short-run instability in relation to increases in M?
In the short run, increases in M do not always translate directly into inflation, especially with excess capacity or liquidity traps.
This was exemplified during the 2008 Global Financial Crisis with unprecedented monetary expansion without immediate inflation.
What is the concept of velocity variability?
Velocity is not always stable and can change dramatically due to financial innovation, economic uncertainty, and policy shifts, undermining the predictive power of the Quantity Theory of Money (QTM).
This contrasts with monetarist assumptions that velocity remains constant.
What do Post-Keynesians argue about the money supply?
They argue that the money supply is endogenous, responding to the demand for credit rather than being directly controlled by central banks.
What does Fisher’s Equation help to understand?
Inflation dynamics
Fisher’s Equation relates nominal interest rates, real interest rates, and inflation rates.
Under what conditions does the Quantity Theory of Money (QTM) hold?
Extreme cases like hyperinflation
QTM is less reliable in stable economies with financial complexity.
How has monetarism influenced monetary policy?
It shaped monetary policy but now integrates with Keynesian insights
This reflects a shift toward a more blended approach in economic theory.
What tools do central banks use today to manage the economy?
Interest rates and inflation expectations
This marks a departure from strict money supply controls.
