Quantity Theory of $ and Interest Rates

Quantity Theory of Money Definition = the relationship between money, price and real output. Prices correspond directly to changes in the money supply Shown by the equation of exchange MV = PQ M = money supply V = velocity of money (# of times an average dollar bill is spent or “changes hands”) P = average price level Q = Real GDP

?? Money is on the left side MV Goods and services are on the right side PQ

Quantity Theory of Money Copernicus noticed that with the influx of gold and silver from the New World, prices in Europe for goods and services went up (inflation) The theory was developed in the late 19th century Keynes understood that this theory works in the long run but not the short run

Mr. Clifford Mr. Clifford

Real vs. Nominal Interest Rates Nominal interest rate = the percentage increase in money that the borrower pays the lender, including the built-in expectation of inflation Nominal interest rate = real interest rate + inflation premium (the expected rate of inflation) Real interest rate = the percentage increase in purchasing power that the borrow pays to the lender

The Fisher Equation R = I -  R = the real interest rate I = the nominal interest rate  = the inflation rate

Example If the nominal interest rate is 5.02% and the inflation rate is 1.87%, what is the real interest rate? 5.02 – 1.87 = 3.15 Yay basic subtraction!

Mr. Clifford and John Nash http://study.com/academy/lesson/real-vs-nominal-interest-rates-and-changes-in-prices.html Mr. Clifford 2