INFLATION
The Quantity Theory of Money
• A simple theory linking the inflation rate to the growth rate of the money supply.
• Begins with a concept called “velocity” (of circulation of money).
Velocity
• basic concept: the rate at which money circulates
• definition: the number of times the average euro or pound note changes hands in a given
time period
• example:
– €500 billion in transactions in a year
– money supply = €100 billion
– The average euro is used in five transactions
– So, velocity = 5 times per year
• This suggests the following definition:
where
V = velocity
T = value of all transactions
M = money supply
• Use nominal GDP as a proxy for total transactions.
Then,
The Quantity Theory of Money
• A simple theory linking the inflation rate to the growth rate of the money supply.
• Begins with a concept called “velocity” (of circulation of money).
Velocity
• basic concept: the rate at which money circulates
• definition: the number of times the average euro or pound note changes hands in a given
time period
• example:
– €500 billion in transactions in a year
– money supply = €100 billion
– The average euro is used in five transactions
– So, velocity = 5 times per year
• This suggests the following definition:
where
V = velocity
T = value of all transactions
M = money supply
• Use nominal GDP as a proxy for total transactions.
Then,
