Fisher and the Quantity Theory of Money

“inflation is always and everything a monetary phenomenon”

What did Milton Friedman say about inflation?

inflation is solely caused by a change in the money supply

what do monetarists believe about inflation?

think otherwise to monetarists, as it does not necessarily apply during a recession

what do keynesians believe about inflation?

The Quantity Theory of Money(QTM)

This theory states that money supply and price level in an economy are in direct proportion to one another. When there is an increase in the supply of money, there is a proportional increase in the price level(ie. inflation)

“too much money chasing too few goods”

How is QTM often summed up as?

more money=>more demand=>but supply stays the same=>shortage=>signals firms that their prices are too low=>higher prices to ration out excess Qd

How does the Quantity Theory of Money work?

MV = PQ

Fisher euqation of exchange

M is money supply, V is velocity of circulation, P is price level, Q is quantity of output

What do the variables represent in the Fisher equation of exchange?

V and Q are constant, hence an increase in M will increase P

To explain inflation, the fisher equation assumes that

V is not constant, M can increase without increasing P if there is spare capacity, P^ causes M^ rather than M^ causing P^

Keynesians reject the QTM in three significant ways

rational consumers will always quickly spend their money on goods/services

Why do monetarist believe that v will always be constant

sometimes more rational to save, causing v to fluctuate as certain factors vary

Keynesians argue that V is not constant as it is

when there is spare capacity cost push inflation is minimal and demand pull is not an issues as there is still spare capacity to increase supply to meet growing demand

Why do Keynesians believe that M can increase without increasing P if there is spare capacity

when the price level rises, the government must supply more money due to a greater need for money to pay for higher prices

Why do Keynesians believe that an increase in P causes M to increase rather than M increasing causing P to increase