The Quantity Theory of Money

Classical View

By: Dr Anup
Outline

➢ Brief of Quantity Theory of Money

➢ Avoiding Basics of Theory: Cases of Germany and Venezuela

➢ The Classical Quantity Theory of Money

2
 Brief of Quantity Theory of Money

❑ The Quantity Theory of Money is an economic theory that posits a direct

relationship between the quantity of money in an economy and the level of prices.
It suggests that changes in the money supply will directly impact the overall
price level in the economy.

❑ It also shows causes, effects, and social costs of inflation.

3
 • At the end of World War I, Germany was required to
pay reparations to the Allies
Hyperinflation in • Germany began running large deficits

Germany • Unable to tax or borrow enough to pay, Germany began

printing large quantities of money.
• Prices started to rise.

4
Price of a newspaper in Germany, 1921-1923:

Date Price in marks

January 1921 0.30
May 1922 1
October 1922 8
February 1923 100
September 1923 1,000
October 1, 1923 2,000
October 15 20,000
October 29 1,000,000
November 9 15,000,000
November 17 70,000,000
5
Hyperinflation &
Money Supply in
Germany

6
How Germany Solved it?
• Fiscal reform ended the inflation

 At the end of 1923, the number of

government employees was cut by a third

 A new central bank was created

 This demonstrated a commitment to not

printing money

7
 Recent Case of Hyperinflation: Venezuela Crisis

❑ Venezuela had begun encountering continuous and uninterrupted

inflation since 1983, with double digit inflation rates.
❑ However, the inflation rates reached its peak under Nicolas Maduro’s
governance in 2014 i.e. around 69% which was highest in the world
and continued to massively rise in the following years.
❑ In 2018 the country had experienced the worst case scenario in the
world economic history with an annual inflation rate being around
1300, 000%.

8
Venezuela’s Annual Inflation Rate

9
Venezuela: Inflation rate from 1985 to 2024

10
 Reasons of Venezuela's inflation

➢By 2013, the Venezuelan government was heavily spending

on social affairs due to high revenues generated from oil
exports.
➢Oil exports generated 90% of the economy's revenue. But
when oil price crashed in 2014 the Venezuelan economy
shrank by 30% over the next three years
➢In March 2013, Nichloas Maduro succeeded Hugo Chavez
as president.
➢Maduro held the same views as Chavez that money
printing was the solution to almost every problem in the
economy.
➢After 2013 the money supplies increases at a rate of 76%
yearly.
➢Printing money can sometimes help in short run shock run
price shock but it was not the case in Venezuela.
➢Oil prices as well as output continued to fall.

11
 The Classical Quantity Theory of Money

THE EQUATION OF EXCHANGE

• The starting point for the classical quantity theory of money is the equation of exchange, an
identity relating the volume of transactions at current prices to the supply of money times the
turnover rate of each rupee.
• This turnover rate for money, which measures the average number of times each dollar is used
in transactions during the period, is called the velocity of money .
Irving Fisher, noted this identity as
MV = PT

#where M is the quantity of money, V is the transactions velocity of money, P is the

price index for the items traded, and T is the volume of transactions

12
Another expression of the equation of exchange focuses only on
income transactions

MV = PY

Money Supply * Velocity = Price level * Income

➢ We can treat velocity constant.

➢ We know that income is affected by real inputs like the availability of

labor, capital, and technology—not the money supply.

13
 Money Supply and Prices

MV = PY

If velocity is constant and income is not determined by the money supply (in the long run),

then:

All that’s left is M and P, and they have to move together.

When M↑ P↑

14
Money Supply and the Price Level

15
Money Supply and the Price Level

16
 THANK
YO U !

Dr. Anup
anupk.yadava@ddn.upes.ac.in

Cabin #K1212, Second Floor, SoB, UPES.

Office Hours: Thus & Friday; 11 – 1 PM

17