In economics, the velocity of money refers to a key term in the quantity theory of money, which centers on the equation of exchange: Face-to-face trading interactions among on the New York Stock Exchange trading floor Economics, may just involve more otriches than you think social science, studies the production, distribution, and consumption of commodities. ... In economics, the equation of exchange is MV = PQ where M is the quantity of money, V is the Velocity of money (how fast it is changing hands), P is the price level, and Q is the quantity or GDP. Categories: | ...

where

M is the total amount of money in circulation in an economy at any one time (say, on average during a month).

V is the velocity of money, i.e., how often each unit of money is spent during the month. This reflects financial institutions and other economic conditions.

P is the average price level for the economy during the month.

Q is the total number of items purchased during the month with the particular kind of money represented by M.

For example, if M represents Central Bank notes (for example, green paper U.S. dollars) then Q is the quantity of goods or assets bought with Central Bank notes. If M represents Central Bank notes plus checking account balances, then Q represents the quantity of goods or assets bought with paper or checking account balances. Textbooks carelessly define Q (or "Y") as the total quantity of goods produced in the economy (i.e., real gross domestic product). But this can lead to serious errors. For example, if only 30% of goods are bought with paper or checking account balances, and if the quantity of this type of money doubled, then it might happen that the quantity of goods bought with paper or checking account balances would double from 30% to 60%, while real output of goods (and P and V) are unaffected. Besides money can be used to buy goods produced in another time period (especially assets). An example of Money. ... The price level is a measurement of the average level of prices in an economy. ...

The left-hand side of the equation above equals the total amount of money spent during the month. The right-hand side equals the amount of money received.

Given this identity, the velocity of money can be measured as

In an early work espousing the quantity theory, velocity is defined as 'the ratio of net national product in current prices to the money stock.'¹ In number and more generally in algebra, a ratio is the linear relationship between two quantities of the same unit. ... Net National Product (NNP) is the total market value of all final goods and services produced by citizens of an economy during a given period of time (Gross National Product or GNP) minus depreciation. ... In economics and business, the price is the assigned numerical monetary value of a good, service or asset. ... Money supply (monetary aggregates, money stock), a macroeconomic concept, is the quantity of money available within the economy to purchase goods, services, and securities. ...

Historically, the main rival of the quantity theory has been the real bills doctrine, which says that the value of money is determined by the assets and liabilities of the money-issuing entity, rather than by the ratio of money to real GDP. The Real Bills doctrine (RBD) is a theory of money creation within the context of a fixed specie basis of money, for example a gold standard; it argues that issuing bank notes against short term private credit is not inflationary. ...

Principles

The theory is based on the following principles:

1. The source of inflation is always, fundamentally, derived from the money supply.
2. The demand for money is a function of wealth, the rate of return and the value of liquidity.
3. Money demand is stable in the short run.
4. The long run is what matters most; injection effects are not that important.
5. The real rate of interest is determined by non-monetary factors (productivity of capital, time preference).
6. The supply of money is usually exogenous.
7. Money demand determines the real money supply.
8. The purchasing power parity doesn't matter for money effects.

To meet Wikipedias quality standards, this article or section may require cleanup. ... This article or section is in need of attention from an expert on the subject. ... Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. ... In economic models, the long run time frame assumes no fixed factors of production. ... In politics, a capital (also called capital city or political capital — although the latter phrase has a second meaning based on an alternative sense of capital) is the principal city or town associated with a countrys government. ... Time preference is the economists assumption that a consumer will place a premium on enjoyment nearer in time over more remote enjoyment. ... Exogenous (or exogeneous) (from the Greek words exo and gen, meaning outside and production) refers to an action or object coming from outside a system. ... In economics, purchasing power parity (PPP) is the method of using the long-run equilibrium exchange rate of two currencies to equalize the currencies purchasing power. ...

Inflation

The equation of exchange can be used as a rudimentary theory of inflation. If the velocity of money is given by financial institutions (such as the role of bank accounts and credit cards) and the amount of production is always at a fixed level (say, at full employment), then any increase in the amount of money leads to rising prices for the economy as a whole, i.e., inflation. In economics, full employment has more than one meaning. ...

If V and Q are constant, then we can state the equation of exchange in terms of rates of growth:

the rate of growth of the money supply = the inflation rate

In economics, the inflation rate is the rate of increase of the average price level (a measure of inflation). ...

Critics

Critics point to several principles presented above. Money supply is endogeneous, as money is created by banks and other financial institutions in relation to a general optimism on the future return of investments. Private supply of money fluctuates in the short and long term and the central bank can only try to level off these fluctuations but has no control on the amount of supply of money. Indeed all central banks have failed in their attempts to target a given monetary growth. There can be huge variation in the stock of goods (especially production goods), goods produced in former period, and held and not consumed by economic agents. Whether economic agents try to add to their stock of goods or to unload it, it has an impact on the number of transactions for a given level of production (flow) and hence on inflation-deflation. Thus money demand also depends on expectations. If consumers expect both a rising consumption and rising prices they tend to add to their stocks, stocks rotate faster, there are more transactions, money demand is higher, and for a given money supply, deflation happens. Expectations are hence crucially important as optimism may lead to both higher money supply and higher money demand and pessimism to both lower money supply and money demand. Private money supply often overreacts to money demand through credit booms and credit bust, just as investment overreacts variation in the demand of final goods in the real sphere, hence the central bankers must try to keep things stable and regulation of he finance industry is to be advocated. Finally, for a given money supply, inflation can happen in consumption good prices or in production good prices (assets), and this depends from the relative strenght of labor and management of the labor market. For instance recent disinflation is less due to monetarist policies than to free trade and anti labor policies which boost profits while depriving labor of their pricing power.

External Links

• calculate M,V,P and Q with your own values to understand the equation

See also

• Income velocity of money
• Monetarism

In economics, income velocity of money is the number of times an individual unit of currency turns over (i. ... Monetarism is a set of views concerning the determination of national income and monetary economics. ...

References

Note 1: Friedman, Milton and Schwartz, Anna J. (1965). The Great Contraction 1929–1933. Princeton: Princeton University Press. ISBN 0-691-00350-5.

Listen to this article · (info)

This audio file was created from an article revision dated 2006-01-02, and may not reflect subsequent edits to the article. (Audio help)

More spoken articles