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# MV=PT Irving Fisher was probably the most popular economist of the early twentieth century.

That said, a popular economist is a bit like a monogamous rock star or a wild and crazy accountant or a Victoria Secret model without breast implants! Everything is relative! In 1911 he came up with the "Equation of Exchange" concept. That equation was MV=PT, where M was representative of the amount of money, V equaled velocity, P was price and T represented transactions. A landmark theory, many people consider the equation to this day to be the single most important mathematical description of economics. Others downplay its significance or find it mildly useful. It helps their case that Irving was quoted as proclaiming just before the crash of 1929, "Stock prices have reached what looks like a permanently high plateau". Needless to say his finances suffered in a significant way. He was also the first president of the "American Eugenics Society". These folks have strong beliefs on selective breeding, the human kind that is! Since we are concerned with how this equation could be applied to monetary policy, whether "Fiat" or fixed, we can solve for M or Money by dividing both sides by V or velocity. M= PT/V Money equals price times transactions divided by velocity. Now, the most common problem people have with Irving's formula is with V. If we omit V entirely, we come up with an equation that is hard to argue with. M=PT The amount of money equals the number of transactions times the price. Barring theft, fraud or force, we should be able to accept this as a basic truth. Fisher's definition of V was the total expenditures for a time period, usually a year, divided by the average amount of money in circulation for the same time period. Another practical definition for V or Velocity is the number of times that it takes the Money Supply to circulate before the total output or PT, of the economy is purchased. Whoever was following the greenbacks around to prove that one should be given an extra star! A valiant effort to say the least!

Often. the hope is that the number of transactions will increase or the Velocity will fall or a combination of the two will occur. "what goes around comes around". If these results don't come to pass nor reach the extent needed to balance the change in M. is it just that the number of transactions is decreasing or is the overall "speed" dropping? A simple solution for this example is the use of V as the "factor" in this equation. V can be determined. then P increases. This is all without considering "monetary inflation" which is the loss of value of the currency because there is more of it in circulation. if they receive a foreign buyer. Is it possible V could represent the "extent" of credit? And what about the present situation. the reason given for the dismissal of a "fixed" currency is the limits or constrictions it places on an economy. by issuing Securities. inflation will be the usual result. All the numbers are in. this is an intricate web. we know M or money and we know the amount of transactions and the price. the results are not the same. at any time by the actions of our Government. Since. is that at any moment in the economy. We could even perceive it as the "human" element. A bit of mystery won't hurt too badly! In our "Fiat" world. The Treasury. resource or actual capital. all money is being used at all times. except for rare instances. over time the money supply is increasing. It can represent the "phantom" or missing element. does a fixed value M place restrictions on output? . Money. As you can see by the equation above where we solved for P or Price. aside from that in your wallet or under the mattress is used and reused constantly and essentially always has the same velocity. V is the directional or determining force. P=MV/T When the value for M is made greater. with gobs of money being injected. Even if this policy is successful. M can be altered and is altered.One good argument against any variation of V at all. and extremely hard to trace in a world market. Kind of like. for the context of our discussion. can introduce "outside" money to our economy. We have seen what a variable M does to Irving's equation. an influence outside the usual realm of supply and demand of labor. Unless there was previously a significant overproduction with a corresponding slowdown in the demand for labor. The policies and actions of the Federal Reserve and the Treasury determine the level of M. The economy has been stimulated by "false" capital. As you can imagine. We can be certain though. the possibility of price inflation looms on the horizon. there isn't a lot of room to wiggle.

The basic idea behind money creation is to bring the future to the present. The "Fiat" system in the best light would be hard pressed to offer us this combination. it should be noted that because this method of monetary control is a "directed" method. using different. the benefits or the resulting drawbacks can and are directed by whoever is controlling the release of monies to wherever in the economy they deem worthy of the good effects or whoever is deserving of the bad effects. By entering a greater amount of M into the system now. we are attempting to jump ahead to a point in the future of the economy where greater output has already been reached. With a fixed system. when more transactions occur in an economy with a fixed currency. The "Fiat" policy stresses the importance of the left side of the equation. As the economy grows. money is constant but gains value because there are more goods and services or commodities represented by the same amount of currency! Fixed M doesn't limit the economy. What is more important to us. what we do everyday to make our lives what they are or money? Do we value our labor and the natural world and how we bring the two together to survive. we might come up with another outlook. the economy limits or multiplies the value of M without changing the amount. almost always increasing amounts of M to attempt to determine the outcome of the right side. any increase in T must coincide with a decrease in P or an increase in V to maintain the equation. If we leave the scope of both Economics and Mathematics and look at things a bit more philosophically. we all share in the profit as our currency becomes stronger and is able to purchase more. how we use our labor to craft resources to meet the needs of our daily lives determines the value of the medium of exchange [money]. This isn't to say that prices can't inflate and/or transactions can't fall or velocity won't slow with fixed currency. This is basically an attempt to experience the benefits without doing the work required. In relation to the M=PT/V equation perhaps the biggest difference between a "Fiat" monetary system and one based on a fixed value is which side of the equation we deem the most vital. Although beyond the scope of this discussion. prices must fall or the velocity must increase or both. What it is saying is that what happens in the economy directly affects the value of money without any change in the amount.If we set M as a constant amount. On the working side of the equation. the results that the economy provides us on the right side of the equation determine the value of the left. When the economy grows in a healthy way. enjoy and create what we call our economy or . That is. prices can actually experience downward pressure.

do we grant the dollar excessive power over our lives? The choice seems simple. changing government income and expenditure. We can think of national income as gross domestic product. It does provide us with some clues as to the underlying debate on the subject. Keynesians believe that fiscal policy. Task 1 Assume that there was a high level of unemployment in the economy. the value of output in an economy over a given period of time. Monetarism is the belief that changes in the quantity of money in circulation in an economy is a determinant of the level of national income. The argument is not so much about whether money supply does in fact act as a determinant of national income .most economists would agree that it has a role to play but on the extent to which changes in the money supply impact on national income. Why is an awareness of the speed with which a policy instrument like monetary policy works through to the economy important in your decision making? This difference manifests itself in the appropriate policy that is to be focused on in dealing with economic problems. The importance of this distinction is in the implications it has for policy makers. You are charged with devising a policy to reduce the level of unemployment. Keynesians would believe that changes in the money supply will take some time to work through to national income whilst monetarists believe it is likely to happen far more quickly. is a more . a Nobel Prize winning economist and foremost thinker on monetarism. what does it take for us to be allowed to make that choice? What is Monetarism? "Inflation is always and everywhere a monetary phenomenon" is an often quoted line from Milton Friedman.

effective means of dealing with problems such as inflation and unemployment. it has to have some predictive value. Let us assume that nominal income is £1 billion. or 100 million 'goods' sold at a price of £10 each. The two sides of the equation. To be an effective theory. or a million 'goods' sold at £1. states the following: MV = PT • M is the money supply. That could mean 1 billion 'goods' produced and sold at £1 each. therefore.000 each. The extent to which it can be claimed to be a theory is thus debatable. Monetarists believe that monetary policy should be the primary weapon in dealing with these problems. named after its founder Irving Fisher in 1911. the amount of money available in the economy V is the velocity of circulation. The Equation of Exchange Why do monetarists believe in the power of monetary policy? In simple terms. The equation of exchange. or the Fisher equation. . or indeed any other combination of price and quantity. How is that nominal income purchased? It is purchased by using the notes and coins (let us assume that 'money' is notes and coins for the moment) in circulation and the number of times it changes hands depends on the price that each good is sold for.it is obviously true. The equation of exchange is often cited as being a truism . Let us assume that M = 500 • number of times the stock of money changes hands in purchasing transactions over a period of time • • P is the price level T is the number of transactions P x T is referred to as nominal income. their views stem from a statement called the equation of exchange. The velocity of circulation refers to the for transactions.

let us say it has a value of 50. the stock of money in circulation (500) changes hands 50 times to buy the output of the economy. The amount of goods produced and the value of those goods must be the same as the amount of money available and the number of times it was used to purchase that output! From Equation to Theory Fisher then made some important assumptions that gave the equation some predictive qualities. What now happens to the price level? • MV = PT . or at least only rises by a small amount over time.are just a different way of saying the same thing. Now let us assume that we want to find the price level. What is the price level? A bit of simple arithmetic gives us the answer: • • • • MV = PT 500 x 50 = p x 200 25. The velocity of circulation was assumed to be relatively stable over a period . In other words. Now assume that there is some boost to the money supply . Remember that the velocity of circulation is assumed to be stable. Assume that T rises to 205.000 = 200p P = 125 This tells us that the average price of each good that changed hands was 125.perhaps due to the government printing more notes or the discovery of new reserves of gold. Assume that we know that the number of transactions in the economy is 200. M now rises to 600 as a result. We might also further assume that the number of transactions or the output of the economy is also relatively stable.

the price level has risen by 17. Concern over the rate at which the money supply grows. However. if the money supply is M and monetary transactions totaling M occurs in 1 month then the money supply turns over 12 times per year so V=12/year P is the price level. the MPC reported that 'credit and broad money growth remain rapid' .5%. What has been the cause of this rise in the price level? The rise in the money supply! The money supply increased by 20% but the output of the economy (the number of transactions) increased by only 2.in other words.3 In this example. Essentially this says how quickly the money supply is turned over. V is the velocity of money. we can see that the rate of economic growth was around 2.000 = 205p P = 146. therefore. So MV = PT means that the total transactions at the current price .6%. it seems fairly obvious that the money supply has an impact on the price level or inflation. the money supply was increasing rapidly. For example. might be of concern to policy makers charged with controlling inflation.04%. When we look at the statement issued by the Bank of England after the Monetary Policy Committee (MPC) raised interest rates by a quarter point to 5% in November 2006. M is the money supply which includes currency and bank deposits available to the public. T is the real value of aggregate transactions. When we have built in these assumptions.• • • 600 x 50 = p x 205 30.

Now imagine there are 120 million transactions during the year. Imagine the money supply is \$1 billion and the velicity is 12/year so then \$1 billion is spent 12 times per year so a total of \$12 billion is spent. Then the average price of these transactions must be \$100 since 120 million times \$100 = \$12 billion. .level is equal to the total money stock multiplied by how often it is turned over.