Quantity Theory Of Money

Question 1

What is the Fisher Equation of Exchange

Answer 1

MV=PT/MV=PY
M —> money supply
V —> velocity of circulation
P —> average price level
T —> number of transactions in a given time period
Y —> volume of output in an economy within a period of time

Question 2

What is the theory of money

Answer 2

V - doesn’t change as it is based on the spending habits of households
Y - real output changes only very slowly over time so Y does not deviate enough to have an influence on prices
V and Y are constant in the short term

Question 3

What do Keynesians think about the quantity theory of money

Answer 3

V and Y are not fixed
Recession —> V can decrease significantly so there might not be a direct link between the money supply and inflation
Liquidity trap —> increase in money supply lowers the interest rate but interest rates are already low enough so a further decrease will not create inflationary pressure

Question 4

What reasons are there that V and Y are not stable and predictable

Answer 4

V changes when there are changes in the way in which workers are paid —> change from weekly to monthly payments then households will hold money to cover expenditure later in the month so V is reduced
V changes with the introduction of credit cards so instead of little payments there will be one large one at the end of the month so V is reduced
V may fall as a result of bank weakness or low confidence levels reducing the inflationary impact of a rise in the money supply