Wednesday, May 3, 2017

Equation of Exchange (Quantity Theory of Money)

Quantity Theory of Money
Equation of Exchange

Lorenzo in Hong Kong @ AIS wants to know about
Equation of Exchange and how has it been tested.
Monetarists believe that inappropriate monetary policy will cause macroeconomic instability.
Formula  
MV = PQ
M*V = P*Q
(Money Supply (times) the Velocity of Money) = (Price * Quantity or Nominal GDP)

Monetarists want the V (velocity of money) to be stable
(no sudden increases in the money supply)

If the money supply rises faster than the rate of growth then we will have inflation
If the Money Supply doubles the Price Level doubles

1995 - 0 questions

2000  #40
Answer - A Income velocity of money increased



2005 #58 

Answer - E the price level will increase

2008 #21
Answer - B Nominal national income


If velocity is stable, meaning that the factors affecting it change gradually and predictably, changes in M lead directly to changes in Nominal GDP (PxQ)
2010 #16

Answer - A increase in nominal output

If the economy is expected to grow at 2 percent in a given year, the Fed should allow the money supply to increase by 2 percent. The Fed should be bound to fixed rules in conducting monetary policy because discretionary power can destabilize the economy.­
2012 #59

Answer - E Long Run RGDP

Practise Test Question (No idea where it is from)
Answer - A Monetarists believe V is stable

People have a stable desire to hold money relative to other financial assets. 
If the money supply is stable and V, velocity is stable then total spending is stable

From Chinese Booklet (no idea where it came from)
Answer - A.

Answer - E