THE VELOCITY OF MONEY M*V = P*Q

Velocity refers to the number of times that a dollar is spent in a period of time, usually one year.

EQUATION OF EXCHANGE M * V = P * Q M = MONEY SUPPLY V = VELOCITY OF MONEY P = PRICE LEVEL Q = REAL GDP

M*V=P*Q M = Money Supply – The stock of money, usually M1: Currency in circulation, traveler’s checks and checkable deposits

M*V=P*Q V =Velocity of money - the speed at which money circulates through the economy. It is also understood as the average number of times a dollar is spent on final goods and services per year.

M*V=P*Q P = Price level – The average price level of the final goods and services in GDP

M*V=P*Q Q = Real GDP – Real output equals the quantity of goods and services in GDP

Note that the velocity of money depends on the definition of money. Source: Joseph Stiglitz, Economics, W.W. Norton & Co., 1993.

M1 is the money supply of currency in circulation (notes and coins, traveler’s checks [non-bank issuers], demand deposits, and checkable deposits). M1 VELOCITY

M2 component includes M1 in addition to saving deposits, certificates of deposit (less than $100,000), and money market deposits for individuals M2 VELOCITY

MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand: notes and coins in circulation, traveler’s checks (non-bank issuers), demand deposits, other checkable deposits, savings deposits, and all money market funds MZM VELOCITY

IF THE MONEY SUPPLY INCREASES V MUST FALL. Q MUST INCREASE. P MUST INCREASE. SOME COMBINATION Changes in the Money Supply Impacts Other Economic Variables

The Monetarists’ View of Monetary Policy is as follows: 1. Changes in the money supply cause direct changes in AD and thereby changes in nominal GDP. 2. The key formula is MV = PQ 3. Velocity should be kept relatively stable. 4. Real GDP (Q) can increase 3 – 5% per year. 5. If Q increases 3 – 5% per year, any increase in M above 5% merely increases the price level. 6. Increases of less than 3% in M mean Q cannot increase by 3% or that the price level falls. 7. Therefore, strict monetarists would use the monetary rule to advocate that the money supply grow at the rate of growth in real GDP in order to maintain economic stability.

RELATIONSHIP AMONG THE GROWTH RATES OF MONEY, VELOCITY, PRICES, AND REAL OUTPUT

Class Exercise Year M V P Q $ GDP 1980 $ $ Fill in the blanks

Class Exercise Year M V P Q $ GDP 1980 $ $