1. Quantity Theory of $ and Interest Rates

2. 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

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

4. 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

5. Mr. Clifford
Mr. Clifford

6. 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

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

8. 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!

9. Mr. Clifford and John Nash
Mr. Clifford 2