Understanding Fisher’s Equation of Exchange: MV = PQ Flashcards
What is Irving Fisher’s Equation of Exchange?
MV = PQ
What does M represent in Fisher’s Equation?
Money Supply: Total amount of money in circulation.
What does V represent in Fisher’s Equation?
Velocity of Money: Rate at which money circulates in the economy.
What does P represent in Fisher’s Equation?
Price Level: Aggregate level of prices.
What does Q represent in Fisher’s Equation?
Real Output: Inflation-adjusted total production of goods/services.
True or False: Fisher’s Equation of Exchange is always valid.
True
The real-world application of Fisher’s Equation depends on what?
Assumptions made about its variables.
What does Money Supply (M) refer to?
Total cash and deposits in an economy.
Controlled by central banks through interest rates and quantitative easing.
What is the Velocity of Money (V)?
Measures how frequently a unit of currency is spent.
High V indicates an active economy; Low V indicates economic stagnation.
What does the Price Level (P) determine?
Inflationary or deflationary pressures.
What is Real Output (Q) equivalent to?
Real GDP; measures the economy’s total goods/services production.
What is the long-term economic goal related to Real Output (Q)?
Full employment.
True or False: The Money Supply is controlled by individual consumers.
False.
Fill in the blank: High Velocity of Money indicates a(n) _______ economy.
active
Fill in the blank: Low Velocity of Money indicates _______ stagnation.
economic
What happens in the short run when there is an increase in M, assuming V is constant?
It leads to either demand-pull inflation or output expansion.
What is demand-pull inflation?
It is when a higher money supply increases aggregate demand, pushing up prices.
Under what condition can an increase in M boost output (Q) in the short run?
If the economy operates below full employment.
In the long run, what determines Q according to the classical view?
Labor, capital, and technology.
What happens to prices (P) once full employment is reached in the long run?
Increasing M only raises P, causing inflation.
Who argued that inflation is always a monetary phenomenon?
Milton Friedman.
Complete the quote: ‘Inflation is always and everywhere a _______.
monetary phenomenon.
What do monetarists argue is the fundamental cause of inflation?
Inflation is fundamentally a monetary phenomenon.
According to monetarists, what leads to higher aggregate demand?
An increase in the money supply.
What happens to demand push when the economy reaches full employment?
It can only manifest as higher prices.
Who famously stated that ‘Inflation is always and everywhere a monetary phenomenon’?
Milton Friedman.
What key assumption underpins the monetarist view regarding the velocity of money?
V is stable or predictable.
What is the central variable in inflationary analysis according to monetarists?
M (the money supply).
What historical events contributed to inflationary pressures in the 1970s?
An increase in the money supply and rising oil prices.
Which equation helps explain the link between the money supply and price levels?
Fisher’s equation.
In scenarios where output (Q) is unable to keep pace with demand, what occurs?
Rising price levels.
Fill in the blank: According to monetarists, inflation results from an increase in the _______.
money supply.
What caused the Weimar Hyperinflation between 1921-1923?
Germany printed excessive money to pay war reparations
This led to a significant increase in the money supply (high M).
What was the relationship between real output (Q) and hyperinflation during the Weimar period?
Real output (Q) could not keep up, causing hyperinflation.
How did fluctuating velocity (V) affect inflation during the Weimar Hyperinflation?
Fluctuating velocity (V) worsened inflation.
What economic situation characterized the 1970s stagflation?
High inflation occurred alongside high unemployment.
What happened to the money supply (M) during the 1970s stagflation?
Increased M, but V fell due to economic instability.
How did Fisher’s model relate to the dynamics of inflation during stagflation?
Fisher’s model oversimplified the dynamics, as V was not constant.
What monetary policy did central banks use after the 2008 financial crisis?
Central banks expanded M via quantitative easing.
Why did inflation remain low after the 2008 financial crisis despite increasing money supply?
Inflation remained low because V dropped (low spending, high savings).
What did the post-2008 financial crisis demonstrate regarding changes in velocity (V)?
Changes in V can override effects of increasing M.
Fill in the blank: Germany printed excessive money to pay war reparations, leading to _______.
hyperinflation.
True or False: During the 1970s stagflation, both inflation and unemployment were low.
False.
What economic condition existed when V fell during the 1970s stagflation?
Economic instability.
Fill in the blank: The expansion of money supply via quantitative easing after the 2008 crisis led to _______ inflation.
low.
What does V represent in Fisher’s Equation (MV = PQ)?
Velocity of money
True or False: V is considered constant in Fisher’s Equation.
False
What empirical data contradicts the assumption of constant V?
1970s stagflation, post-2008
What factors affect the velocity of money (V)?
- Consumer confidence
- Technological advances
- Policy shifts
What is the full employment assumption in economic theory?
The assumption that all resources are utilized efficiently
True or False: Full employment is always realistic.
False
What can increasing M (money supply) lead to when there is excess capacity?
Boost Q rather than P
What are some structural and institutional factors that affect inflation?
- Labor markets
- Trade balances
- Global commodity prices
What does Fisher’s Equation (MV = PQ) provide a framework for?
Understanding monetary dynamics
What must be acknowledged for the real-world application of Fisher’s Equation?
The variability of V and deviations from full employment assumptions
How does modern economic analysis differ from Fisher’s model?
It incorporates complexities beyond Fisher’s model to better explain inflation and economic fluctuations
